Have you ever wondered about the long-term value each customer brings to your SaaS business? An important concept answers just that — it’s called Customer Lifetime Value, or CLTV for short.
Now, CLTV is an insightful metric for any company to consider, but we’d argue it’s especially key for those of us in the SaaS space. In short, CLTV represents the total profits a user can generate for your business over the full span of their customer lifecycle. By getting a handle on each user’s CLTV, SaaS companies can forecast future revenues more accurately, understand potential causes of churn, and make plans to improve their retention rates.
In this post, we’ll explore CLTV — what it means for your SaaS business and why you should monitor it closely. We’ll also examine the individual variables that make up the CLTV metrics and examine how they affect a company’s valuation. And don’t worry — by the end, we’ll discuss a few ways to increase your average CLTV. Let’s get started.
What is Customer Lifetime Value?
So, what exactly is this concept of Customer Lifetime Value (CLTV)? At its core, CLTV represents the total revenue a customer contributes during their entire time as a client or user of your product or service.
It’s not just about the first sale — CLTV also accounts for repeat purchases, renewals, upgrades, and any other revenue-generating activities that occur during a customer’s lifecycle.
Technically, we calculate CLTV by taking the total revenue generated from someone and subtracting all the expenses involved in acquiring and supporting them as a client over their customer lifecycle. This gives us the net profit that a particular person brings to the business.
Here’s the formula we use to calculate customer lifetime value:
CLTV= (Average Order Value × Number of Purchases Per Period × Gross Margin) × Retention Rate/1−Retention Rate − Cost to Acquire Customer
Now, let’s break down each variable in this formula so you know which metrics you need to pull to find your CLTV.
Variables that Contribute to Total CLTV
A customer’s CLTV depends on several different individual SaaS metrics. By understanding how each piece fits into the bigger puzzle, SaaS companies can strategically focus on the areas that will provide the biggest boost to their average customer lifetime value.
Let’s take a closer look at some of CLTV’s key drivers:
- Customer Retention Rate: This is the percentage of folks renewing their subscriptions during each billing cycle. Even small bumps here have an outsized impact on your average CLTV because renewing users provides additional recurring revenue during the customer lifecycle. Plus, retaining customers is often cheaper than finding new ones.
- Average Order Value (AOV): This is the amount that your customers normally spend per transaction. A few ways to increase this metric include bundling products together, offering higher tier plans, or promoting add-ons that make sense for your users’ specific use case. Ultimately, generating more revenue per user lifts their lifetime contribution.
- Gross Margin: This is the percentage of each sale that you actually keep after your expenses, and it also factors into your total CLTV. In short, the higher your margins are, the higher CLTV you’ll have.
- Churn Rate: This is the number of customers who don’t renew during each billing cycle. The more customers stick around, the more revenue they’ll contribute, which ultimately will increase your customer lifetime value.
- Contract Length: This metric, which is typically measured in years or months, has a direct impact on your CLTV. Longer user commitments mean more potential revenue periods when calculating your CLTV.
- Expansion Rate: This is the percentage of users that purchase additional services or add-ons. This additional revenue is considered “expansion revenue” and also factors into the total revenue generated during the customer lifecycle.
Why CLTV is a Critical Metric
There are plenty of SaaS metrics that deserve a spot on your company scorecard. But what makes CLTV a standout metric for SaaS companies?
While common metrics like monthly recurring revenue and churn provide useful snapshots, CLTV offers SaaS executives a long-range view into the true financial impact of their customer base. Rather than focusing solely on initial sales or short-term goals, CLTV underscores the importance of nurturing customer relationships for sustained profitability over time.
With this CLTV data on hand, businesses can assess which customer segments, plan levels, and acquisition channels generate the highest lifetime profits. This insight allows business resources to be allocated strategically — for example, doubling down on customer support or incentives for top-value customer segments. Optimizing variables that boost CLTV also produces a compounding effect — even incremental improvements in your retention, expansion, or average contract values can significantly increase the total revenue attributed by each user across your customer base.
It’s also worth noting that as CLTV goes up across your customer base, so too does the overall valuation of the company. This is because investors recognize that optimizing CLTV translates directly to strengthened long-term cash flows and reduced risk of investment for shareholders. With a solid understanding and management of CLTV metrics, you can then make informed decisions about how to plot out your future product roadmap, pricing strategy, GTM model, and every other aspect of your business that impacts your company’s cash flow.
And, most importantly, by focusing on CLTV, executives shift their orientation from short-term deals and quick wins to nurturing their existing customer relationships and maximizing profitability.
How CLTV Impacts SaaS Company Valuations
Now, let’s talk about how CLTV impacts the total valuation of your SaaS company. If you have your sights set on an eventual exit or IPO, then you need to get a handle on this metric.
For starters, CLTV serves as a key indicator of a SaaS company’s long-term potential and risk profile. As such, it represents an important consideration in valuation multiples. All else being equal, businesses that demonstrate steadily increasing CLTV will attract higher valuation multiples from investors.
CLTV metrics have also factored directly into high-profile M&A deals. For example, in its $4.75 billion acquisition of Marketo, Adobe cited the marketing software provider’s industry-leading CLTV as a strategic rationale for the acquisition.
There is also a clear link between CLTV and the “Rule of 40,” a benchmark for high-growth SaaS companies. The rule states that revenue growth percentage plus profit margin percentage should add up to 40% or more. Effectively managing CLTV helps companies achieve this balance by increasing both their top-line growth from incremental revenue per user and their margins from customer acquisition and retention.
What Your CLTV Metric Reveals About Your Business
Beyond telling you how much customers are spending over the course of their time with your company, the state of your CLTV metrics also sheds light on key areas that can shape business success. Let’s dive deeper into what some of these insights could reveal about your business’s performance.
Your CLTV Is Steadily Increasing
A steadily climbing average CLTV over time likely signals a strong product-market fit. If your customers keep seeing the value of your SaaS, they’ll be more likely to spend more over a longer period of time. This shows that your solution solves real user pain points just as well, or better, than the competitors in your space.
Your CLTV Has Plateaued
But what if your CLTV has plateaued? If this is the case, then it may signal that your pricing is too low or that your customers are motivated to purchase add-ons or upgrade to higher-tier subscription plans. If you’re stuck here and churn isn’t an issue, you need to double down on monetizing your existing user base. Whether that means raising your prices, implementing a new pricing model, or assigning customer success managers to incentivize users to upgrade their plans, you need to be focused on generating additional revenue from your users.
There’s a Large Gap Between Your Average CLTV and Median CLTV
A large gap between average and typical CLTV also warrants investigation. It may signify that your company is overly dependent on a handful of big spenders who make up its total MRR and ARR. While these “whale” users are great to have, ideally, you should be encouraging your Sales teams to bring in new customers with similar levels of spending.
By narrowing this spread, you’ll be more resilient against losing major customers that make up the bulk of your company’s revenue.
How to Improve CLTV
Once you have a solid understanding of your benchmark CLTV, you can start taking steps toward improving this metric. Here are a few different ways you can increase your CLTV.
Increase Customer Retention
If you want to increase customer retention, you can first focus on building proactive touchpoints with your users throughout the customer lifecycle. For example, sending renewal reminders or sharing the success stories of other users with similar use cases — these are both low-effort ways to stay in constant contact with your customer base and ensure that your company stays top-of-mind.
Additionally, you can gather feedback from customers who choose not to renew their contracts, which will provide your team with insights into important customer pain points that may be contributing to user churn. Once you have a deeper understanding of these pain points, you can test incentives designed to improve retention, such as offering existing customers free months or discounts for referring new customers.
You should also ensure that your customer success program provides ongoing support and monitors the churn risks of your users across individual customer segments. If you notice that certain customer segments are more at risk of churn than others, you can begin to implement retention strategies that will improve the likelihood of renewal.
For instance, you may consider offering additional onboarding options like free training sessions or implementation support to help foster long-term value and loyalty. These activities are crucial, because the more you shorten your users time-to-value, the more likely they’ll be to renew their subscriptions and continue using your SaaS.
Expand Customer Value
To expand customer value over time, start by running targeted marketing campaigns to sell your customers additional products and services. That is relevant to their specific use case. For instance, if their product usage is increasing, you could upsell them on priority customer support to ensure that they never have to worry about downtime. Ultimately, these “upsell” and “cross-sell” efforts will help increase the average amount each customer spends.
Similarly, it’s important to understand your customers’ typical journey with your company. By nurturing a deep knowledge of the path your customers usually take — from initial onboarding to renewal to churn — you’ll gain insights into the right types of offers to present at each stage. For instance, if your customer is starting their onboarding journey, you may present them with any additional add-ons that could be helpful to their specific use case, increasing the chances that they’ll increase their average order value.
It’s also worth noting that you’ll want to personalize these offers for different customer segments. First, analyze your existing customers to see which user demographics may be most interested in specific add-on modules or expansions. Then, you can continually test these offers to see which segments are most likely to make additional purchases.
Test New Pricing Strategies
Finally, rolling out new pricing strategies is another great way to continually monetize and retain your existing customer base. However, when testing these price changes, be sure to start small.
You may start by rolling out new pricing for a small subset of customers to gauge their response. And keep in mind that changing your pricing doesn’t necessarily mean raising or lowering how much you charge for your service. You can also experiment with different pricing methods, such as usage-based billing, variable-based pricing, and sales-negotiated contracts.
Once you’ve launched this new pricing, you can monitor how these changes affect your total revenue and churn rates. But ultimately, measuring the CLTV for the customer segments you’re testing this new pricing on will tell whether or not this new strategy will be viable long-term for your company.
Track, Measure, and Improve Your CLTV with Maxio
Understanding customer lifetime value (CLTV) is critical for the success of any business, but the importance of CLTV is even more pronounced for SaaS companies.
Since SaaS businesses rely heavily on recurring revenue from existing customers, understanding the lifetime value of each customer is crucial to their success. By using the CLTV calculation, SaaS companies can identify which customers are most valuable, which customer segments to focus on, and how to optimize pricing and marketing strategies.
Want to track and measure CLTV in your SaaS business? Schedule a demo with our team to get started.