Your Customer Lifetime Value (LTV) is the total amount a customer is worth during their lifetime with your business. It gives you an idea of how much repeat business you can expect from a customer and how much you can spend on acquiring and retaining them.
How do I determine my LTV?
There are multiple ways to calculate your LTV. You may use your Average Revenue Per Account (ARPA), gross margin percentage or Churn percentage. In this lesson, we will be using the following to determine your LTV:
- Average revenue per account (ARPA)
- Average purchase frequency
- Average customer lifetime
The formula is very straightforward–multiply all of the above, and you’ll have your LTV!
ARPA x Average purchase frequency x Average customer lifetime
= Customer Lifetime Value
You can then use your LTV to do a customer segment analysis. Customer segmentation does wonders for your business because it helps you build deeper relationships with your customers.
For instance, focusing on a specific customer segment allows you to identify and innovate new products or services to ensure product success. Instead of allocating resources in research and development to roll out features for every customer segment, you only need to focus on a selected group of customers. In return, you can expect a longer-term customer loyalty (=revenue). Your LTV helps you determine which customer segment to focus on.
Let’s take a look at the following examples:
Customer Segment 1
You offer a monthly subscription of $99 per month, and your customer makes monthly purchases every year for the next three years. We know that your:
- Average purchase value = $99 / month
- Average purchase frequency = 12 times (in a year)
- Average customer lifetime = 3 years
Multiply them:
$99 x 12 x 3 = $3564
Your LTV for Customer Segment 1 is $3564 in total revenue.
Customer Segment 2
Assuming you have another monthly subscription for $79 per month and your customer makes monthly purchases for the next three years. Your variables are:
- Average purchase value = $79 / month
- Average purchase frequency = 12 times (in a year)
- Average customer lifetime = 3 years
$79 x 12 x 3 = $2844
Your LTV for Customer Segment 2 is $2844 in total revenue.
Customer Segment 3
In this scenario, we’ll keep the variables in Customer Segment 2 but lengthen the average customer lifetime to five years instead. You now have:
- Average purchase value = $79 / month
- Average purchase frequency = 12 times (in a year)
- Average customer lifetime = 5 years
$79 x 12 x 5 = $4740
Your LTV for Customer Segment 3 is $4740 in total revenue.
Who should you be paying more attention to? The answer is, the customers in Customer Segment 3.
Here’s why:
The total revenue tells you the maximum amount you should be spending on acquiring your customers in order to be profitable–hello, Customer Acquisition Costs (CAC)!
Based on the examples above, the customers in Customer Segment 3 not only generates a larger amount of total revenue and is more valuable to your business. They also have a longer customer lifetime.
That’s correct–The longer your customer lifetime, the better. You want to keep your customer for as long as you can and try to expand your net revenue retention through upselling and cross-selling.
Key takeaway:
During the early stages of your business, it is normal for your CAC to be higher than your LTV. Your key objective in the long run is to ensure that your LTV is much higher than your CAC. An ideal LTV to CAC ratio for a growing SaaS business is 3:1. Otherwise you will not be able to scale your operations and build a profitable business.
Go deeper: Achieving the ideal Customer Lifetime Value to Customer Acquisition Costs ratio
Happy Calqulating!
