LTV in SaaS: a 101
Any business needs actionable metrics. That is, ways to track how well they’re doing; measures to give insight into questions like:
- Is the product working well?
- Is service good?
- Are our customers happy?
- Are we making a profit?
One such metric for SaaS businesses is LTV, or lifetime value. Lifetime value in SaaS not only paints a detailed picture of performance, but can help to direct future efforts too.
So, here’s an overview of LTV in SaaS – from what it is, to what you can use it for.
LTV in SaaS explained
LTV is short for lifetime value. It’s a measure of how valuable a customer is to the business in terms of revenue over the course of the customer’s relationship with the business. It’s also known as CLV, or customer lifetime value.
Lifetime value, regardless of the business type, is tricky to calculate accurately. This is because it relies on knowing when customers are going to churn.
However, the typical equation for calculating lifetime value is:
So, you divide the average revenue you will get from a customer by how often your customers churn. Because this is not necessarily an easy thing to predict, this is then multiplied by 0.75 (or your gross margin rate), which gives a more conservative indication of customer lifetime value.
What LTV means for SaaS
In SaaS, the revenue of an account climbs steadily, with each monthly subscription payment adding to the revenue. This can mean that customers subscribing for a long time have a high lifetime value. (For instance, when compared with a business model in which a customer occasionally buys a new product/offering.)
With LTV in SaaS, it’s also much easier to predict how much a customer spends with you over a set time — say, the course of a year. You know they will spend X amount every month. So, you have a more accurate idea of the revenue you’ll get for the customer account during a fixed subscription period.
LTV in SaaS is important because it’s an actionable metric, telling you something that you can use to determine what to do next.
What is LTV used for?
Customer retention correlates highly with SaaS profitability. That is, the longer you have your customers, the more profitable your SaaS business is. By calculating LTV, then, you get a view of how well your business is performing.
Additionally, LTV is a useful tool for predicting future financial decisions. It helps you get an idea of where to allocate resources, how much you’ll have to work with to grow your business, and which areas to support more than others.
What do different LTV rates mean?
Depending on what your LTV rate looks like, you’ll need to take different actions.
• A low LTV
Low LTV in SaaS means that the lifetime value of your customers is below what you might expect.
This is particularly problematic if your LTV is lower than the cost of acquiring your customers — it means you’re losing money. (I.e., you’re paying more to get customers than you get back.)
Low LTV can also be a sign of a high churn rate, meaning you aren’t keeping customers for long enough. So, use it as a signal to check your churn rate. You can then analyse and improve any areas where your SaaS offering might be falling short.
Another cause for low LTV in SaaS is that your average revenue is low. This means that you may not be charging as much for your software/service as you could be. Or that your pricing strategy needs reviewing.
However, low LTV caused by low average revenue isn’t necessarily a bad thing. For instance, it may be because you’re supporting a large number of customers for a lower price — and the lifetime value adds up to a good level of profit.
• A high LTV
In SaaS, high LTV is the most desirable outcome. It suggests not only that you have high-paying customers, but that you are keeping them subscribed to you for a long time. (The core goal of any SaaS business.)
With a high LTV, you can start to consider spending more on customer acquisition. This, in turn, would allow you to scale your business further as you attract (and keep) more highly valuable customers.
• A fluctuating LTV
LTV in SaaS can fluctuate wildly from customer to customer or month to month. For example, this happens when:
- You have a small sample of customers
- You operate in an unclear market
- You’re currently expanding or adapting
These factors can create an unreliable churn rate due to changing customers and needs.
A fluctuating LTV is the hardest one to deal with. For some customers it suggests the business is doing well, and for others, it suggests there’s a problem.
When you have a fluctuating LTV, it’s a good idea to look at other, non-revenue-based SaaS metrics. Analysing measures such as satisfaction scores, for example, can give you an idea of whether your product is performing well or not.
LTV in SaaS: a powerful metric
While not the only metric at their disposal, lifetime value is a powerful metric for SaaS companies. It gives a clear indication of whether the company is doing well, whether it is ready to expand, and gives direction to future resource allocation. LTV in SaaS can vary wildly. But knowing what the different types of LTV scores mean provides a valuable insight into the present — and future — of the SaaS business.