Customer Lifetime Value – “Never Allow it to be Alone”
In today’s newsletter we dive deep into the following details on the Customer Lifetime Value (CLTV) metric including:
One of my top six predictions for 2025 is the growing importance of Customer Lifetime Value, but with a caveat and that is how it relates to the cost of acquiring a customer otherwise known as the Customer Lifetime Value to Customer Acquisition Cost Ratio.
Let’s dive in!!!
Customer Lifetime Value Defined
Customer Lifetime Value (CLTV) measures the total revenue a company can expect from a customer over the length of their relationship. This metric helps a company understand the return from investing in Sales and Marketing to acquire new customers.
One of the hallmarks of a recurring revenue business model is that the majority of the revenue generated from a new customer is not recognized upon initial customer acquisition, but rather over several years. The total revenue a new customer generates over its lifetime is impacted by other variables including customer retention rate, the ability to expand the relationship, and associated revenue with well defined up-sell and cross-sell processes.
Understanding Customer Lifetime Value (CLTV) is not as straightforward as you may think - let’s start with the formula itself:
Customer Lifetime Value is a multi-variable, compound metric. The first thing to calculate is Average Revenue Per Account (ARPA), which in and of itself requires dividing total revenue in a period by the number of active accounts (customers) in the same period. A common question is which customers should be used to calculate APRA?
I recommend using all customers on active agreements for the entire period. This effectively excludes customers that churned during the period and also excludes new customers brought in during the period which have not yet produced the expansion ARR that most customers will generate over time.
Using GAAP revenue is an acceptable alternative to using ARR, and better aligns private company calculations with public companies who do not report ARR.
A second metric used in calculating CLTV, Gross Margin measures the percentage of Gross Profit a company generates to revenue. The Gross Margin calculation formula is:
The importance of Gross Margin adjusting the Average Revenue per Account (ARPA) is that it shows the cash generation potential of each new customer after factoring in the costs to deliver the product.
Churn Rate is another key variable impacting CLTV, and is best calculated by ARR churn versus the number of customers churned.
Solutions with an ACV lower than $1,000 can benefit from calculating churn based upon the number of customers, however we recommend all other companies use the formula below:
Gross Revenue Retention Rate is not the primary topic of this newsletter, but the GRR calculation can be seen at the SaaS Metrics Standards Board website.
Calculating Customer Lifetime Value by customer segments, by products purchased and by time-based cohorts are best practices and enables SaaS companies to understand how different segments perform as measured by CLTV. This can also provide insights into which segments have the highest lifetime value to help to determine priorities on which segments to invest more Sales and Marketing resources.
Customer Lifetime Value - The Benefits
There are multiple benefits of calculating and understanding Customer Lifetime Value including the below:
?? Prioritizing customer acquisition investments
Understanding CLTV helps identify which customer segments are most valuable over time, enabling companies to prioritize Marketing, Sales and Customer Success investments on acquiring and retaining customers with the highest lifetime value
?? Prioritizing customer retention investments
By understanding which customer segments have the highest Customer Lifetime Value, it informs the Customer Success team which customers to allocate more resources to increase the customer retention rate, thus providing the foundation for increased customer expansion revenue
?? Prioritizing customer expansion investments
By understanding which customer segments have the highest Customer Lifetime Value it can also inform Marketing, Sales and Customer Success teams which customer or segments of customers to focus on for cross-sell and up-sell opportunities
?? Product development insights
CLTV analysis can inform product development prioritization decisions by revealing which products and features utilized correlate to the highest customer retention and thus the largest Customer Lifetime Value
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?? Improving customer onboarding
By analyzing CLTV data, companies can identify areas where onboarding processes can be enhanced to increase product utilization and thus customer lifetime value
?? Identify lower value customer segments to avoid or de-prioritize
Though it may go without saying, understanding Customer Lifetime Value by customer segment helps to identify those customer segment(s) that may not justify the investment to acquire or require a different approach to increase CLTV
Customer Lifetime Value - The Cautions
As an optimist who prefers to focus on the positives of any situation or metric, it is critical to understand some of the common mistakes that are made when using the Customer Lifetime Value metric:
? Overall Customer Lifetime Value can be misleading
For companies that sell to multiple customer segments, such as to Enterprise and mid-market customers, the CLTV for each segment can be quite different. The same issue applies to multi-product companies based upon which product(s) a customer uses.
As such, calculating Customer Lifetime Value by customer segment, using the below segment variables is an important level of granularity as a company grows
? Not understanding the impact of each CLTV component
CLTV is a compound metric which is impacted by each variable used to calculate it. As an example, a strong expansion ARR motion may materially increase the CLTV for customers still on active agreements, but does not highlight the impact of high customer churn as measured by Gross Revenue Retention.
When using CLTV as a key outcome metric, understanding and assigning management responsibility for each input metric is a best practice.
? Using CLTV in ISOLATION - always combine it with at least two partner metrics
Customer Lifetime Value analyzed in isolation provides little context as to if a company’s CLTV is great, good, bad or just plain ugly.
If a company told me it had an average $100,000 Customer Lifetime Value - the very next question I would ask is “what is your average Annual Contract Value (ACV)?”.
A simple example is a company that has a $100,000 CLTV and a $50K ACV– I would wonder why the average customer churned in two-three years. But if they had a $10K product and a $100K CLTV, I would be amazed and want to understand both the churn rate and the NRR of their customers.
Below I share why Annual Contract Value and Customer Acquisition Costs are best friends to the Customer Lifetime Value metric.
Customer Lifetime Value - The need for Partner Metrics
I previously highlighted knowing the actual Customer Lifetime Value number is of little value without the context of two other key metrics.
The first CLTV context is knowing the Annual Contract Value (ACV).
Below are two companies with the same Customer Lifetime Value but with two very different ACV’s:
As you can see from the above example - the Customer Lifetime Value of both companies is $375,000. However, when you look at all three of the input variables used to calculate Customer Lifetime Value you can see that Company #2 appears to be more attractive as even with an ACV of only $25,000 (versus $75,000) they both produce the same CLTV of $375,000.
There are two other key variables which begin to tell the rest of the story, and this is that Company #1 has a 20% churn rate, two times Company #2’s 10% churn rate. At the same time, Company #1 has an Average Revenue per Account (ARPA) that is 33% higher than the original ACV of $75,000, while Company #2 has an ARPA of $50,000 which is 100% higher than the original ACV.
But wait - at the end of the day what’s really important to understand is the Return on Investment (ROI). So let’s expand the analysis to understand how Customer Lifetime Value compares to the Customer Acquisition Cost - which is called the Customer Lifetime Value to Customer Acquisition Cost Ratio (CLTV:CAC Ratio):
Historically having a CLTV:CAC Ratio of 3:1 was viewed as good, but that ratio has been increasing over the last few years and is now closer to 4:1. This can be seen in the below chart from the Benchmarkit 2024 SaaS Metrics Benchmark Report.
Summary
Customer Lifetime Value is a core metric that 82% of SaaS companies calculate. Unfortunately, less than 50% of companies calculate the CLTV:CAC Ratio. Even more concerning is that only about 42% of Sales and Marketing leaders calculate Customer Lifetime Value and less than 20% know and use the CLTV:CAC Ratio to help inform their Go-to-Market investment priorities.
Think about this in context of being a personal investor - if you know the value of your current investments is $1,000,000, but have no idea of how that compares to the initial investment or the annual rate return you are achieving, how would you determine if it is a good investment and/or the right investment for the future?
Customer Lifetime Value is a valuable metric when used in CONCERT with the primary input metrics and in CONTEX of Annual Contract Value and Customer Acquisition Cost.
Do not let your Customer Lifetime Value be alone - pair it with some friends!!
I Dispel B2B SaaS Pricing Illusions
1 个月Good post, Ray! Always a smart idea to pair "contra" metrics that might prevent you from being led astray! What company revenue level have you seen be a minimum bar when CLTV becomes trustworthy?
CFO Partner at SeatonHill Partners
1 个月Great data here, Ray, and well explained.
CMO & Founder at B2B Fusion | Enhancing Pipeline Growth & Visibility
1 个月Great read for SaaS Marketers of all levels who need to marinate in how the business, not just Marketing, thinks. This one sentence struck me in this time of Profitable Efficient Growth on focus: Though it may go without saying, understanding Customer Lifetime Value by customer segment helps to identify those customer segment(s) that may not justify the investment to acquire or require a different approach to increase CLTV.