When developing and implementing a customer experience program, customer satisfaction and Net Promoter Scores are two important KPIs to track because they help your company measure customer satisfaction and loyalty. However, Customer Lifetime Value (CLV) doesn’t get as much attention as it should, despite being a critical metric that affects recurring revenue businesses. Most subscription-based and SaaS businesses depend on recurring payments, so keeping an eye on customer retention and lifetime value rates can pay dividends. Let’s take a look at what customer lifetime value is and how it affects recurring revenue businesses.
What is Customer Lifetime Value (CLV)?
Customer lifetime value is a metric that helps companies measure the total revenue generated over the period (or lifetime) they have been an active customer. In other words, it’s an estimate of the average gross revenue that a customer will generate before they cancel (or churn). The longer a customer continues to buy your products/services (or subscribe to a business), the bigger the lifetime value becomes.
Why Should You Care about CLV?
Calculating your CLV will help you understand how to align your product management, marketing, and sales processes. You will know when to apply a limit to your CAC (Customer Acquisition Cost) – if you are spending more on new customer acquisition than you expect to earn from a customer in revenue, you will start losing money. But by aligning the aforementioned processes, you will increase net profits and bring additional benefits to customers.
By measuring CLV in relation to CAC, it becomes possible for your company to measure ROI for every newly-acquired customer, which will help you estimate your marketing budgets and sales more accurately. Estimating CAC with the help of CLV can also be helpful in determining the commissions you can offer to your sales reps for closing deals. Typically, it’s suggested that CAC should be around 1/3 of the CLV, meaning – CLV > 3 x [sales commission + [cost per lead x lead-to-close ratio)].
By regularly calculating and updating customer lifetime value (for every customer) and rewarding your sales reps for how much future expected value they’re bringing to the business, you will be able to boost your sales reps’ morale and motivate them. Furthermore, CLV can help your product management team understand the true value of your offering because that value depends on whether the customers are willing to purchase it on a monthly basis. It cannot be judged only by the sales numbers, but also on how its presence or absence can affect the CLV of the people who buy it.
CLV and Customer Churn Rates
The churn rate is the rate at which customers stop doing business with a company due to failure to renew (passive churn) or cancellations (proactive churns). It is usually measured on a monthly basis. For a business to expand its clientele, the growth rate must exceed the churn rate.
When estimating CLV, factoring in customer churn rate is one of the challenges because churn patterns are varying. The simple CLV formula assumes that customer churn occurs linearly over the lifetime of a customer, but in reality, that’s never the case. The four typical churn patterns look like this:
- Cliff churn patterns – The majority of the churn in these patterns occur within the first month, and then a smaller percentage of constant churn afterward;
- Annual renewals – Customer churn occurs evenly over time, with a larger churn at each contract renewal;
- Declining – Shows a churn rate starting at 0 and increasing at 0.25% each month;
- Constant – Steady churn rate.
If your company’s customer churn contains a mixture of these churn patterns, you should apply a discount to adjust your simple CLV formula to account for that variance. Also, you can calculate CLV per customer segment to get more meaningful results, such as calculating CLV separately for clients paying annually vs. monthly.
The complete formula for CLV looks like this:
CLV = 0.75 x (ARPACust. Churn Rate) + [m(1-Cust. Churn Rate) / Cust. Churn Rate]
- For a more conservative estimate, we multiply with 0.75 to compensate for variable churn;
- The second section is the base CLV formula;
- The third section is added to allow for linear account expansion (“m” – monthly growth in average revenue per account). Account expansion refers to an increase in recurring revenue after the initial purchase (e.g., plan upgrade).
How to Use CLV
When you get an accurate estimate of your CLV based on the characteristics of your business, you need to apply the rate in situations where it is useful. You can use CLV to:
- Focus on improving customer retention rate. Minimizing churn is one of the most critical undertakings for recurring revenue businesses, especially through rapid growth. Improving your customer service, building better customer relationships, and looking after your most valuable clients could greatly impact your company’s ability to maintain MRR (monthly recurring revenue) growth.
- Track your CLV to Customer Acquisition Cost (CAC) ratio. Your customer acquisition cost (CAC) tells you how much money (on average) you are spending to acquire new customers. If your CLV/CAC ratio is not 3 or higher, your company could be spending too much money on acquiring new customers. For the recurring revenue business model, improving customer retention creates more value than customer acquisition. Tracking this ratio will help you determine the health of your subscription model business. For example, SaaS businesses spend around 5-7 times more money on customer acquisition. These are large investments, so your company needs to ensure that you are recouping those investments. When CAC is lower than CLV, it means that there’s a positive ROI on investment for your acquisition efforts.
- Evaluate the most valuable marketing channels. To prioritize marketing channels that acquire the most valuable users, you should measure CLV for each marketing channel.
How to Improve Your CLV
The longer you keep a customer, the greater the value they provide during their relationship with your business. Improving your CLV can be as simple as switching your billing cycle from yearly to monthly, or it can be as challenging as overhauling the entire customer support process. Some of the best tactics for improving CLV include:
- Creating a high-value offering
The products that address the most prominent customer pain points and provide a quick and effective solution to their problems are products that usually perform the best. When building your product or service, your enterprise must carefully consider the needs and problems of its customers and find a way to demonstrate how your offering can add value to their life. Highlight the benefits of your offering and frame it in terms of a continued partnership to encourage your clients to stay loyal to your brand.
- Customer satisfaction
Poor customer experience is the number one reason why people stop doing business with a company. For subscription-based companies, the ability to keep customers engaged and prove to them that they’re getting incremental value from your business is what ensures long-term success. Recurring revenue businesses need to adopt a customer-centric attitude as early as the onboarding process. When onboarding new customers to your business, consider offering a high degree of personalization to make things as streamlined as possible.
- Give an upgrade
If you have long-time customers who are openly and actively engaging with your brand, they are the best ones to receive the full experience. For example, if you have a product line, send them something they haven’t tried. If you have a service, give them a premium upgrade for free. It will have a huge, positive impact on them, and they will definitely mention that to their colleagues, friends, or social followers.
- Listen to what your customers have to say
Everyone can benefit from some constructive feedback. Businesses can boost their growth by listening to their customers’ feedback and implementing their suggestions to improve products/services and prioritize the aspects of the business that fuel revenue growth and customer satisfaction. Furthermore, it allows businesses to understand their customer, and customers will feel validated, like they’re part of the team, when they see that you’re listening. Collect and store the feedback you receive and share it across all your departments.
- Use a dunning management system
A dunning management system is a great solution for alleviating the frustrations your clients may experience from having to deal with an invalid or outdated payment option. Credit or debit card charges can fail for different reasons (e.g., credit card limits, expired cards, stolen cards, lost cards, etc.), and you don’t want your customers to experience any interruptions due to failed credit card charges. Implement a dunning management system that will proactively alert your clients that their payment information is expiring soon. That way, you will prevent interruptions in your revenue stream, while still delighting your customers with your service.
The cohesiveness between your products and the customers who have been doing business with your company for the longest is one of the vital components of your success. Companies that characterize themselves as high-growth companies find that customer lifetime value is a critical metric. Keeping an eye on customer retention and lifetime value rates is important for recurring revenue businesses because they depend on recurring payments to sustain themselves.
Consero is here to help you understand that you cannot track or understand any metric without the right tools. We can help you calculate, understand, and apply the CLV (or any other) metric better and make your data available across your organization to keep everyone on the same page.