Companies track a set of performance metrics that are standard to their industries or important for measuring the specific aspects of their individual businesses. One metric might demonstrate business health in one industry, while being irrelevant in another. But across most sectors and business stages, customer lifetime value (LTV) is a key metric that indicates whether a business is succeeding with its customers—and where it has room for improvement.

In the world of SaaS, LTV represents both the current state of revenue optimization and the potential long-term success of a business. Whether you’re at a small startup or a well-established company, understanding and maximizing LTV can create a sustainable, profitable customer base and provide you with valuable insights and actionable strategies for driving business growth.

Below is what SaaS businesses need to know about how to calculate and increase LTV; the most common methods of calculating LTV; and tactics for improving customer retention, upselling, and cross-selling and acquiring new customers.

What’s in this article?

• What is customer lifetime value?
  
• How to calculate customer lifetime value
  
• How is customer lifetime value measured?
  
• Why customer lifetime value is important for businesses
  
• How to increase customer lifetime value
  

What is customer lifetime value?

Customer lifetime value (usually expressed as LTV, CLV, or CLTV) is a metric that helps predict how much net profit a customer will generate over the entire span of their relationship with a business. It evaluates the potential value of a customer to a business, and it informs strategic decision-making by helping businesses identify and prioritize their most valuable customers and allocate resources accordingly.

How to calculate customer lifetime value

LTV is typically calculated by multiplying the value generated per customer by the length of their lifespan as a customer. For some industries, it makes more sense to measure customer lifespan in months; for others, years is a more appropriate measure. For example, automotive companies might measure LTV in years, since few customers purchase more than one vehicle in any given year, and customer retention efforts are focused on driving repeat purchases over a timeline that extends for many years.

There are different ways to calculate LTV, but a simple method is:

LTV = (Average value of a transaction) x (Average number of transactions) x (Customer lifespan)

For example, if a customer spends an average of $100 per purchase and makes a purchase once every six months, with a retention time of five years, the LTV would be:

LTV = ($100) x (2 purchases per year) x (5 years) = $1,000

Most businesses add other metrics to this simpler equation—such as customer acquisition cost, gross margin, and customer referrals—to obtain a more complete picture of efficiency and profitability.

How is customer lifetime value measured?

Businesses should continually monitor LTV, since this metric is influenced by constantly evolving conditions. And there’s more than one way to calculate LTV. Depending on the industry and markets businesses operate in, they might consider several different LTV formulas to get more nuanced insight into their current and future financial health.

LTV can be measured by using the following methods:

• Historical LTV
  This method uses past sales data to calculate the average revenue generated per customer over a certain period of time.

• Cohort analysis
  This method groups customers by the time period in which they made their first purchase (e.g., by month or quarter). Then the LTV is calculated for each cohort based on its revenue and retention over time. This method can identify patterns in customer behavior and compare the LTV of different customer segments.

• Predictive LTV
  This method uses statistical models to predict the future LTV of a customer based on their past behavior and demographics. This method can identify high-value customers, allowing businesses to make data-informed decisions about the best use of their resources.

• Retention-based LTV
  This method is based on the number of repeat purchases, average purchase value, and customer retention rate. The formula for this method is:

LTV = (Average revenue per transaction) x (Number of repeat transactions) x (Retention rate)

• RFM analysis
  This method considers three factors:

  • Recency: When was the last purchase made?
    
  • Frequency: How often do they purchase?
    
  • Monetary value: How much do they spend?
    

Businesses can calculate LTV using any of these methods, for their customers as a whole or for certain cohorts. To better understand prospective profitability, they can then compare LTV to customer acquisition cost (CAC). One of the key indicators of profitability is when CAC is lower than LTV.

Why customer lifetime value is important for businesses

LTV is important for SaaS businesses, because it helps them understand the long-term value of each subscription customer as well as the cost of acquiring and retaining those customers. This enables businesses to make informed decisions about sales, marketing, and product development. There are very few aspects of running a SaaS business that aren’t influenced by LTV.

LTV is also a key metric for evaluating the overall health of the business and setting goals for growth. Additionally, having a good understanding of LTV can inform pricing and customer engagement strategies, helping SaaS businesses maximize the value they extract from each customer over time. LTV provides a holistic view of customer value and can help businesses make data-driven decisions to increase revenue and profitability.

Here are a few specific areas where LTV can impact business strategy:

• Prioritizing customers
  LTV helps businesses identify their most valuable customers and prioritize them accordingly. This enables businesses to make informed choices about how much to focus on retaining and growing their highest-value customer segments vs. boosting their efforts with lagging cohorts.

• Marketing and sales strategy
  LTV can inform the development of marketing and sales strategies. For example, businesses might use LTV to identify the most cost-effective channels for acquiring new customers, the most effective methods for retaining existing customers, and where inefficiencies exist in the marketing and sales funnels.

• Budgeting and forecasting
  Businesses can use LTV to influence budgeting and forecasting across the business, predict future revenue streams, and make data-driven choices about the most advantageous places to invest their resources.

• Identifying cross-selling and upselling opportunities
  LTV demonstrates how efficiently a business acquires and retains customers, but it also uncovers opportunities to increase revenue from existing customers through cross-selling and upselling.

• Long-term planning
  By estimating future revenue streams and the growth potential for different customer segments, LTV helps businesses with long-term planning. LTV can also indicate the potential of untapped market segments.

How to increase customer lifetime value

There are several ways businesses can increase LTV:

• Focus on customer retention
  LTV is linked to many other business metrics, including customer retention. By providing an exceptional customer experience, businesses can increase customer satisfaction and loyalty, leading to repeat transactions and longer retention times. Businesses can achieve this with fast, friendly customer service, consistent product quality, strong communication, an intuitive and conversion-optimized website, and an accommodating return policy.

• Invest more in upselling and cross-selling efforts
  Another way to increase LTV is to entice customers to spend more. For most businesses, this means cross-selling and upselling. Businesses can increase the average value of a sale through strategic merchandising during the checkout experience, bundling popular products together, offering complementary products or services to existing customers when they make a purchase, or incentivizing customers to move into a higher tier of product functionality or membership access.

• Concentrate on subscription-based models
  Subscription-based models can increase LTV by providing a recurring revenue stream. For example, a company that sells a product in a monthly subscription box will have a higher LTV than a company that sells the product only one time. Similarly, the SaaS business model is based on the idea that LTV increases when customers pay a small recurring fee for continued access to a software product, rather than paying a higher one-time price to own it outright.

• Stimulate customer loyalty
  Beyond focusing on their core products and services, businesses have the opportunity to cultivate a holistic experience that keeps customers engaged and excited about their relationship with the brand. Implementing loyalty programs, such as rewards, discounts, and other incentives, can encourage customers to make repeat purchases and remain loyal.

• Personalize the customer experience
  Part of a high-retention strategy involves creating personalized experiences, with your products and your brand as a whole. These can include targeted recommendations, promotions, and communications to build stronger customer relationships, greater brand affinity, and more touchpoints for repeat transactions.

• Improve customer acquisition cost
  By lowering the cost of acquiring new customers, businesses can increase the overall profitability of their customer base, leading to a higher LTV. Understanding which acquisition channels are operating the most efficiently can tell businesses where to focus as they grow. Similarly, knowing which acquisition channels and tactics are underperforming can be instructive, guiding businesses to deploy new optimizations or reroute resources to higher-performing areas.

• Analyze customer data and act on the insights
  A carefully planned metrics-tracking operation is important for maximizing LTV. By analyzing customer data and reviewing reports regularly, businesses can gain powerful insights into customer behavior and preferences, which can inform targeted promotions and improvements to the overall customer experience.

• Create and invest in a brand ambassador program
  Encouraging customers to become brand ambassadors by providing incentives, rewards, and recognition can increase organic referrals, which bring in new customers at a lower cost than traditional marketing methods. Brand ambassador programs are worth exactly what you put into them. They can either be a huge boon for businesses, or a waste of time and money. For an ambassador program to be successful, you need thoughtful planning and robust engagement with your cohort of ambassadors.

• Engage post-sale
  Businesses can increase LTV with existing customers by engaging with them through email campaigns, surveys, high-value content, digital and in-person events, and other forms of follow-up, to encourage repeat transactions and positive word-of-mouth. The key is to consistently nurture positive feelings about your brand, keeping it top of mind, without flooding your customers’ inboxes with unwanted promotions.

Creating and executing a business growth strategy and optimizing revenue potential relies on a clear, functional understanding of the business’s financial performance. But gaining this understanding is more complicated than simply taking a look at the company’s bottom line. Determining which metrics to track, analyze, and act upon requires a great deal of strategic thought. No matter which metrics your team uses to monitor the health of your business, LTV should likely play a prominent role.