LTV (customer lifetime value) is a SaaS KPI. It is an essential piece of data for managing the performance of a company with recurring revenues. Do you know how to calculate LTV and the LTV/CAC ratio? This comprehensive guide will help you calculate and optimize this indicator.
1 - What is LTV?
This indicator is mainly found in recurring revenue businesses such as SaaS, although it is sometimes used to analyze e-commerce performance. Let's look at how to calculate LTV with a concrete example, and how it perfectly complements the analysis of CAC, or customer acquisition cost.
1.1 - Definition of LTV and synonyms CLV and CLTV
LTV, sometimes called CLTV or CLV, is a management indicator that gives the average income generated over a customer's estimated lifetime.
1.2 - How to calculate LTV?
There are several ways to calculate LTV, depending on your company’s sector. An online retailer seeks to estimate the value of the average shopping basket, as well as the customer's purchase frequency and lifetime. In this case, the lifetime value is calculated as follows: LTV = estimated lifetime × average basket × purchase frequency.
💡 For SaaS, the usual calculation is as follows: LTV = ARPA / monthly customer churn rate.
To make this simple, let's break down the terms:
• ARPA (average revenue per account) corresponds to the average MRR per subscriber or customer over a given period;
• Churn rate is the rate of customers lost over the same period (bearing in mind that it's better to calculate churn over a period longer than a month).
For example, if you lose an average of 2% of your customers per month, it will take 100/2= 50 months to lose all your customers and the MRR they generate. So, by dividing the MRR for the period by the churn rate, you obtain the LTV.
This is, of course, a lifetime estimate, but it has the great advantage of enabling SaaS with a limited history to have their LTV calculated on the basis of their actual performance.
💡 LTV is sometimes calculated by multiplying ARPA by gross margin. This gives you an idea of the value accruing to SaaS after direct costs are deducted. The examples given in this article do not take this formula into account.
1.3 - Practical example of calculating LTV for SaaS
Here's a breakdown of last month's SaaS business inflows and outflows:
• 50 customers took out an annual subscription for 120 euros each;
• 100 customers chose the basic monthly package of 12 euros per month;
• 60 customers subscribed to the premium package, worth 18 euros per month;
• the customer churn rate over the last half-year was 3%.
First, let's calculate the average MRR, then the ARPA, and finally the LTV:
• MRR = ((120/12) × 50) + (100 × 12) + (60 × 18) = €2780;
• Number of subscribers = 50 + 100 + 60 = 210;
• ARPA = €2780/210 = €13.24 ;
• LTV = ARPA/churn rate = 13.24 / 3% = €441.33.
1.4 –LTV/CAC complements LTV
LTV therefore measures revenue. The utility of this indicator also lies in its comparison with the cost of acquiring a customer (the CAC).
The ratio of LTV to CAC is used to determine the breakeven point or return on investment of the expenditure required to obtain a new customer.
If you divide LTV by CAC and obtain a ratio that is greater than 3, your SaaS performance metric is healthy. It means that a customer brings in three times as much revenue as it costs to acquire them. So, if the customer’s CAC is €100, they should ideally generate €300 in revenue.
💡 If your LTV/CAC ratio is:
• Below 1, you've either just launched your business, or you're in trouble (because every new customer generates a loss).
• Equal to 1, then acquisition expenses equal revenues. You'll need to keep up your efforts to reach the profit zone.
• Equal to 3, you reach the minimum target to create a scalable and efficient growth engine.
• Above 3, then your strategy is excellent. Be sure to invest heavily in customer acquisition to get ahead.
2 - How to optimize the LTV of a SaaS company?
Knowing how to calculate LTV is the bare minimum. Using it as a lever for the profitability and viability of your business model is even more useful. Here are some actions you can take to improve this KPI.
2.1 - 2 levers for maximizing LTV
Customer lifetime value is calculated by dividing ARPA by churn rate. The two levers for optimizing this ratio are maximizing the numerator and minimizing the denominator.
a - Sell more on average to each customer
Increase ARPA, i.e. the estimated average revenue per customer over a given period. Several solutions are possible:
• increase how much customers pay for subscriptions by up-selling;
• add additional services or options by cross-selling;
• increase your prices (for example, consider annual versus monthly packages).
b - Reduce churn to retain customers as long as possible
The other way to improve LTV with SaaS is to minimize customer attrition. The longer they remain subscribers, the higher your lifetime value. Here are some concrete ways of doing this in our article on churn rate.
💡 And don't forget to compare churn with that of other similar companies. This is one way of measuring your customer satisfaction. For any company, acquiring new users always costs more than retaining them.
2.2 - Deploy customer loyalty initiatives
After-sales service and customer communication in general are other areas to consider. Acquiring new customers involves advertising, but that's not the only time a company needs to take care of its communications.
Once a customer is a subscriber, retain their loyalty by pampering them:
• Ask them regularly about their satisfaction and the benefits they derive from your products.
• Give due consideration to user reviews and comments.
• Always survey lost customers to understand their reasons for leaving and improve your online offering.
And don't forget product promotions. This is one way of rewarding your loyal customers. For example, offer them a preferential rate for a premium subscription, even if this means cutting into your profit margin from time to time.
LTV is one of the key data items to include on the SaaS dashboard, as is the LTV/CAC ratio. The customer, the revenue they generate, and the cost of acquiring them should be among your top priorities. To help you, Fincome can establish your company's favorite KPIs on an online platform so you can focus on the essentials: analysis and corrective action. Request a demo and discover how we help you track your business performance, including LTV.
💡 Complete your reading with the following articles:
- 3 common mistakes that kill SaaS startups
- All you need to know to calculate monthly recurring revenue
- Automated reporting for SaaS: a quick guide
- KPI reporting at every stage of your startup
- Annual recurring revenue: what it is and how it’s calculated
- Why is SaaS financial reporting still crucial for your startup in 2023?
- 5 KPIS for customer success
