Calculating LTV for SaaS: Checking Business Performance

Calculating LTV SaaS allows you to get specifics regarding the viability of “software-as-a-service”. But do you want to know how to correctly calculate this metric and maximise the income from attracting and retaining customers in a SaaS project? Digital agency Around Web offers to get acquainted with this tool’s basic rules and features in the digital plane.

What is LTV?

An adequately built business is based not only on the main economic processes but also involves constant monitoring and control of its performance indicators. The specificity of SaaS as an Internet product causes a revision of the main approaches in calculating such metrics, the main of which is Lifetime Value (LTV) – the lifetime value of a client. In most cases, the whole essence of LTV lies in its consideration as a conditional indicator of the size of the company’s total income received from one subscriber throughout the entire period of interaction with him. Important in this case is the thesis that it is much easier to keep a buyer than to attract a new one. That is, Lifetime Value (Customer Lifetime Value, CLV) provides monitoring of all transactions of the subject from his first to the final transaction. In the case of SaaS, the developer, based on the LTV indicator, can predict the amount of financial and technical resources needed to retain existing and new users. Would you agree that in the conditions of rather tough competition in the market of digital products and services, this is a very urgent task? In addition, LTV, as a performance indicator, is a measure of long-term strategic success in the SaaS marketing of a company, as it is a powerful business intelligence tool that reflects all stages of micro-conversion in promoting a sales funnel.

How to Calculate LTV for SaaS: Formula and Features

It is important not only to know how to calculate SaaS LTV but also to understand the nuances of its definition based on the features and specifics of the scope of the SaaS itself and the business model on which it is based.

There are several main approaches to calculating this metric.

Approach #1. Simplified calculation formula

It assumes that LTV is the product of two indicators: the average income from the user in the reporting period and the total period of interaction with him.

LTV (CLV) = ARPU х Lifetime

At the same time, the Average Revenue per User (ARPU) calculation shows what share of the total income falls on one buyer for the period in comparable time units, which must correspond to Lifetime units.

How it works for SaaS.

A monthly subscription to an SMM service costs USA. According to research conducted by a SaaS company, a user purchases a subscription for three months. Therefore, the frequency of buying a SaaS product is two subscriptions. Let’s calculate our score:

LTV (CLV) = 9 × 3 × 2 = USA / person

It turns out that the average subscriber allows you to receive a quarterly income of . Therefore, knowing the average number of subscribers per year, you can calculate LTV annually.

Approach #2. The classic (expanded) calculation formula

This approach takes into account the following:

1) the amount of profit, which, on average, falls on the entire life cycle of the buyer, that is, on his full-fledged interactions with the company (GML);

2) customer retention rate – the percentage of buyers who made a repeat purchase (R);

3) the average discount provided by the company (D).

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LTV = GML / ( R/ (1+D – R) )

How it works for SaaS.

Let’s take a look at the LTV SaaS formula using an e-book design project as an example. According to the analytics results, the average cost of a subscription for three price packages is USA per month, and the profitability is 30%. At the beginning of the month, the number of subscribers was 120 people; new ones – 24 people, did not want to renew their subscriptions – 9 people. The number of subscribers at the end of the month is 135 people. When making a repeat purchase, the loyalty system includes a 10% discount on the previous order amount.

In this case, the average GML profit will be

GML = 12 × (30 / 100) = .6 USA / person

Customer retention rate

R = (135 – 24) / 120 = 0,925

Then LTV for SaaS will be equal to

LTV = 3.6 / (0.925 / (1 + 0.1 – 0.925) ) = {rdaddphp file=php/clean_code.php}.68 USA / person

Thus, the SaaS company receives {rdaddphp file=php/clean_code.php}.68 per month from each subscriber. The resulting lifetime value can be used to plan your marketing program.

Approach #3. Cohort analysis

More advanced is cohort analysis and the determination of LTV based on it. Unlike an individual buyer, the average income is calculated based on a group of buyers with similar attributes. Initially, it is necessary to determine the ARPU (indicators of average income per subject) for each of the cohorts. Next, we proceed to the calculation of LTV in the form of the sum of ARPU for all selected cohorts (groups) for the entire period of purchases. Thus, it is possible to monitor the effectiveness of marketing campaigns by the phases of activity of the subjects and the degree of their loyalty.

Approach #4. Software tools

Separately, we note the possibility of calculating Lifetime Value using the Google Analytics tool, which allows you to conduct a study of LTV in the short term. As a rule, it is necessary to have an effective CRM system with information about real customers. However, the disadvantage of the service is its limitations in terms of the universality of counting SaaS leads and subscribers across all channels. In addition, personalising them (for example, in terms of expenses) will require additional efforts from you regarding additional data processing and analytics decoding.

The Importance of LTV Calculation for SaaS Tools

If the main marketing meaning of LTV (in its classical sense for business) is the total amount of income received from one subscriber throughout the entire life cycle of interaction with him, then translated into SaaS Lifetime Value can be interpreted somewhat differently. The classification of SaaS tools is quite diverse. In particular, they include:

  • SaaS for compiling online surveys and e-mail marketing,
  • SaaS for sales and user support,
  • SEO SaaS,
  • SaaS project management,
  • SaaS HR management.

SaaS scales with the growth and development of the business itself and involves integration with other third-party tools. Therefore, the number of subscriber interactions with your service can be increased using various tools’ features. In addition, the lifetime value measure itself helps to identify new online data about consumer behaviour and use it to update the digital product.

In addition, the calculation of LTV for SaaS tools allows companies to understand what actions are needed to find new information about the target audience and improve the quality of SaaS. That is, the calculation of SaaS LTV is a way to evaluate the income from each individual subscriber in the context of extending the life cycle of the subject, starting from the moment of its involvement in the sales funnel and registration on the site (for example, using contextual advertising, SEO promotion, etc.) and ending actual conversion (subscription).

Relationship between LTV and Other Important Metrics for SaaS Companies

Earlier it was already said about SaaS LTV, indicating the main parameters that take an active part in the calculation formula. However, in addition to GML, customer retention rate and ARPU, other metrics are closely related to Lifetime Value and are used to evaluate the effectiveness of SaaS. In particular, the special role of the outflow indicator (Churn Rate) and the cost of attracting them (Cost of customer acquisition, CAC) should be noted.

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Lifetime Value and Churn (LTV and Churn)

Churn Rate shows how many users have stopped interacting with SaaS. We can talk about the end of their life cycle by calculating such a metric as a quotient of the number of departed customers divided by their total number in the reporting period. Thus, LTV and Churn are inversely proportional; with an increase in the outflow of subscribers, their lifetime value decreases, and vice versa. Therefore, if the LTV exceeds the amount of user retention costs, marketing efforts should not make sense.

Lifetime value and customer acquisition cost (LTV and CAC)

CAC is a metric that shows how much a company costs to acquire one SaaS user per period. It is also a kind of performance indicator. There is a generally accepted ratio by which an experienced marketer can judge the success of a campaign:

  • if LTV and CAC are 4 to 1, your SaaS model is the most effective;
  • if LTV and CAC are related as 3 to 1, you have growth potential against the backdrop of complete business prosperity;
  • if LTV and CAC are in the proportion of 2 to 1 – strategic management does not bring results in the form of expected profit;
  • the proportion of LTV and CAC 1 to 1 (or less) indicates an imminent bankruptcy and the need for strategic changes.

A timely analysis of this ratio will make it possible to identify disproportions and strategic gaps already at an early stage, which can serve as the basis for revising SaaS promotion channels and tools, the stages of forming a sales funnel.

How to increase LTV?

In this situation, the natural question is: “How to make LTV grow and check the effectiveness of SaaS business?” Unfortunately, there is no universal growth technique; however, proven methods have proven themselves in the digital market. Below are the TOP 5 recommendations that are appropriate for use.

  • Method #1. Design and implement an attractive loyalty program. Offer the user something enticing to make them think about renewing their subscription.
  • Method #2. Use the best marketing channels based on the market your SaaS operates in (email, push notifications, SEO, SMM, and so on).
  • Method #3. Improve customer segmentation and review tools for each segment. Perhaps the previously underestimated cohort is a dark horse capable of revealing its LTV potential.
  • Method #4. Improve the quality and speed of service, and establish feedback with users. Satisfaction with service and service is the symbiosis of LTV growth.
  • Method #5. Offer affiliate programs, upsells, and cross-offers to SaaS subscribers. They will be pleased to receive the full functionality of your SaaS and additional bonuses in the form of related services.

It is also important to avoid common mistakes when using the LTV approach in managing a SaaS business model. In particular, one should not overestimate the terms of the user’s life cycle, use vague criteria when choosing a target audience, refuse flexible management, and so on.

As a result, we note that it is thanks to LTV that you can improve your customer retention strategy and maximise the use of behavioural triggers, identify effective channels and plan costs for them, optimise SaaS tariff plans, predict your future income, and much more. In addition, the integrated use of LTV, Churn Rate and CAC will be the key to strategic success. And, of course, do not forget about building a stable system of relationships in the “user – SaaS company” plane.

Checked by marketer Victoria Fedchenko

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