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What is a SaaS Customer's Lifetime Value?

By William Steward on Wed, Dec 3, 2014

really-workCustomer Lifetime Value (CLV). 

It's a vital metric for SaaS companies to keep an eye on. If your CLV isn't a big enough multiple of your customer acquisition cost (CAC), your company has a problem on its hands. 

But what is CLV, and how can SaaS companies calculate it? 

In this post I explain.

What is CLV?

CLV is officially the total amount of net profit you can expect to collect from a typical customer, but for SaaS companies it's typical to estimate revenue per customer instead. There's a lot of different ways to predict your CLV, with varying levels of complexity ranging from basic calculations to predictive modelling. In today's post I explain some of the simpler ways you can estimate CLV.

The Basic Calculation

At first, working out your CLV can seem quite simple. All you have to do is add up all of your revenue from customers to date, and divide it by your total number of customers. There you have it. You can then do this calculation for individual segments of your customer database -- individual products, or specific packages for example. 

The problem is, if you're calculating your CLV in this way, you're always going to understate it. It gives a conservative "lower bound" for your CLV. The reason for this is that if you're growing rapidly, many of your customers will have only onboarded in the last few months, and won't be representative of the total revenue you will close from them over the coming years. 

A Better Way

To get a truer picture of your CLV, you want to estimate how long you expect a customer to stay with your company, based on your existing customer data. To work out how long you can expect a customer to stay with your business, you need to work out your churn rate (the % of customers which leave you each month).

Once you know the percentage of customers that churn each month, it's a simple calculation:

Customer lifetime = 1 / customer churn rate

So, for example, if you have a monthly churn rate of 2%, your customer lifetime would be:

1 / 0.02 = 50 months 

From this, you can multiply your average customer lifetime by the average monthly revenue derived from each of your existing customers, and determine your CLV. 

Of course, this again isn't a perfect method. Your existing customers may churn at a different rate to the customers you're acquiring now, and this calculation doesn't take into account changes you're going to be making in the future. For example, you may be planning to change your pricing in 6 months, or to cross-sell a new product to your existing customer database next year.

This is where things get a bit more complicated...

Projecting CLV

You can use predictive techniques to estimate what your "real" CLV is. For example, if you know that next June you're increasing your prices, you can factor that increase into your monthly recurring revenue. 

Usually price changes should only have a substantial impact on churn rates in the short term, unless you set them too high. For the purposes of calculating your CLV, you can therefore assume that your average customer lifetime will remain unchanged.

If you're developing a new product, you might try selling it into a small subsection of your customer base, and see which percentage take it up. From there you can apply that sample to the rest of your customer database, and determine what impact launching the new product to all customers will have on your CLV.

New products can impact churn (positively or negatively), but this is difficult to model. A successful product release should reduce customer churn, as well as increasing monthly revenue generated by each customer.

The key is to calculate your CLV to as much accuracy as makes sense. Understanding your CLV is important for determinine a ceiling for your CAC (customer acquisition cost). If you understate your CLV, you risk not growing fast enough, due to trying to keep your CAC too low. Likewise, if you overstate your CLV, you risk burning through capital and acquiring customers which will never go on to generate a profit. 

As a general rule, your SaaS company should be aiming for a CLV that is at least 3x its CAC, to be sustainable. 

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