Customer Lifetime Value: How to Calculate and Increase CLTV?

As a SaaS business leader, you see a steady influx of customers, but your business revenue growth has slowed. Why is this happening?

The answer lies in understanding the revenue each customer generates throughout their lifetime—known as Customer Lifetime Value (CLV).

Understanding this metric helps you determine a customer's true worth and shifts your focus from acquiring customers to scaling revenue growth. With this mindset, you'll retain more customers and build a loyal base that drives long-term success.

This blog will explain the fundamentals of CLV, why it matters, and how to apply the correct formula. We'll also cover strategies to boost CLV and revive your business's revenue growth.

What is Customer Lifetime Value (CLV)?

Customer lifetime value refers to the total revenue a company earns from a customer throughout its entire relationship with the business. It shows how much a customer is expected to spend on your SaaS product over time, offering insights into long-term revenue and customer retention.

For instance, if a customer subscribed to the premium version of your SaaS for six months, the total amount they spent during that period will determine their lifetime value.

Customers' lifetime value increases when they stay loyal to a company and contribute to annual revenue. This means the higher the CLV, the higher your customers value your product and business. 

How to Calculate Customer Lifetime Value?

Now that you understand the importance of customer lifetime value let's learn how to calculate it. Calculating CLV is quite simple, but it's essential to understand its foundational components that make the most of the insights it provides: 

1. Average Revenue Per User (ARPU): This metric refers to the average amount each customer spends in a specific period, such as monthly or annually.

ARPU (annually) = Total ARR / Total Number of Users

2. Customer Lifetime (L): This metric measures the average customer lifespan with your product or service, usually calculated in months or years.

3. Gross Margin (GM): It refers to the percentage of revenue after deducting the cost of goods sold (COGS). Here, revenue is the positive income from the sale of software or its subscriptions. COGS represents the direct costs, including server costs, software licensing fees, and direct support and customer service costs.

Gross Margin (%) = (Revenue – COGS) / Revenue × 100

Customer lifetime value formula

For SaaS businesses, the basic formula is:

Step-by-step customer lifetime value calculation

Average Revenue Per User (ARPU):

• Total Annual Recurring Revenue (ARR) = $10,000
• Total Number of Customers = 50
• ARPU = Total ARR / Total Customers = $10,000 / 50 = $200 per year

Gross Margin (GM):

• Gross Margin = 80% or 0.8

Customer Lifetime (L):

• Average Customer Lifespan = 2 years
  
  Total CLV = $200 x 0.8 x 2 = $320

In this example, a customer's total lifetime value is $320. It represents each customer's average revenue over their business relationship with the service, excluding direct costs.

Why is Customer Lifetime Value Important for SaaS Businesses?

Customer Lifetime Value (CLTV) is a critical metric for measuring the long-term value of each customer. For SaaS models, where revenue depends on monthly and annual subscriptions, calculating customer lifetime value gives a clear view of a business's financial health and supports sustainable growth.

Here are key reasons why Customer Lifetime Value (CLTV) is essential for SaaS businesses:

1. Determine customer acquisition costs

Customer Lifetime Value (CLTV) helps you estimate the total amount invested in marketing and sales to acquire new customers, known as Customer Acquisition Cost (CAC).

While CAC may initially exceed the revenue from a customer's first purchase, CLTV can generate revenue over the customer’s entire relationship with your SaaS business.

Calculating CLTV helps you decide customer acquisition costs to maximize profitability and inspires you to improve your marketing and sales strategies to attract target customers.

2. Reliable business viability

A high customer lifetime value indicates how well your product or service resonates with your customers and meets their needs. It significantly impacts your company's financial performance and credibility in the industry. 

Moreover, it underscores customer loyalty and trust in your SaaS product. The higher the CLV, the more loyal customers you have.

3. Understand customer behavior

Calculating LTV provides valuable data about your customers and can be used to create different customer segments based on their lifetime value and purchasing behavior.

This insight helps you identify customers who tend to stay longer and contribute more to revenue and those at risk of early churn. 

Customer segmentation helps you improve customer retention strategies and tailor campaigns to acquire high-value customers, ultimately optimizing the overall customer experience. 

4. Attract investors

Customer lifetime value (CLTV) is a critical metric that investors and stakeholders use to determine a business's future revenue potential and scalability. 

A high CLTV reflects a well-aligned product-market fit and demonstrates the company's ability to retain customers and generate ongoing revenue. It indicates that the SaaS company guarantees stability and profitability. 

These factors attract investors and stakeholders to invest in the growing business and contribute to their long-term success.

5. Retention and revenue growth

SaaS companies depend on monthly and annual subscription renewals from existing customers. A high Customer Lifetime Value (CLTV) indicates that customers consistently find value in your SaaS product or service.

When CLTV increases, it signals strong customer retention, often achieved through upselling, cross-selling, and enhancing the customer experience. These strategies not only reduce churn but also drive revenue growth.

Three Ways to Calculate Customer Lifetime Value (CLV)

Customer Lifetime Value (CLV) enables a holistic view of the revenue each customer contributes across their relationship with your business. Rather than focusing on single transactions, CLV reveals the total value generated, helping SaaS companies strategically forecast growth and improve customer engagement. Here are three ways to calculate customer lifetime value:

1. Historical Customer Lifetime Value

Historic CLV refers to the total revenue generated by existing customers based on their past purchases, making it ideal for established SaaS businesses with enough data. This method allows companies to identify high-value customers based on their spending patterns.

Formula:

2. Predictive Customer Lifetime Value

The predictive customer lifetime value refers to how much customers can spend on your product or are willing to pay for the subscription.

This approach uses statistical modelling and data analysis to forecast a customer's future value based on various factors, such as purchasing habits and engagement levels. It is more complicated than historical CLV. 

Formula:

• Average Purchase Value: The amount a customer spends per transaction equals the revenue generated from a single purchase.
• Average Purchase Frequency: This measures how often a customer buys over a set period, which indicates repeat purchasing behaviour and customer loyalty.
• Average Customer Lifespan: The total time a customer stays with a company, showing the duration of the customer-business relationship.

3. Cohort analysis CLV

Cohort analysis groups customers based on shared characteristics (e.g., sign-up date, marketing channel) and calculates CLV for each cohort over time. This helps businesses understand how different groups behave.

Formula:

This method of calculating customer lifetime value enables SaaS businesses to identify trends and improve retention strategies for specific customer groups.

Best Practices to Increase Customer Lifetime Value 

Customer lifetime value is a key indicator of your SaaS business's success. The higher your customer lifetime value, the longer you can generate profits and grow. Here are some effective strategies to extend your customer's life and increase their lifetime value: 

1. Provide seamless onboarding

Customer onboarding is introducing your product to new users for the first time. A smooth onboarding experience helps new customers quickly navigate critical features and understand your product's core value, turning them into loyal customers and increasing their lifetime value.

A poor onboarding experience can lead to frustration and prompt users to consider alternatives. To help users navigate the product and improve onboarding,  implement strategies like creating frictionless signups and providing them with easy-to-follow guides and video tutorials.

2. Up-selling and cross-selling

Upselling and cross-selling are effective strategies to extend the customer relationship with your SaaS product. Upselling means offering more features or product extensions to existing customers, and cross-selling means offering other related products and core products. 

For instance, you can recommend a more upgraded version of your SaaS with additional features to the most valuable customers who frequently purchase or renew your software yearly. This can increase their lifetime with your product. Ensure that upselling improves brand loyalty and encourages repeat purchases. 

3. Nurture customer relationships

Happy and satisfied customers can become your most loyal customers. Focus on nurturing your customer relationships to improve your customer lifetime value.

1. Adequate customer support: Provide good customer support during their onboarding process and a well-trained, responsive support team to resolve customers' challenges.
2. Quick responses: Respond quickly to questions and customer feedback, making them feel valued. It allows you to understand the customer's pain points and provide solutions to fix their problems before they churn.
3. Targeted content: Create documentation and user guides to help them understand the product's features and usage.

All these efforts strengthen relationships with your customers, ultimately increasing customer lifetime value.

4. Use ‘sticky’ features

Sticky features keep users engaged longer by solving and eliminating key pain points. The result? They significantly improve your company's customer lifetime value (CLV) and enhance user experience.

For example, Dropbox effectively utilizes "sticky" features, a cloud-based storage solution. Its automatic sync feature continuously backs up files to the cloud, ensuring data is always secure and accessible without requiring manual effort. This business strategy helped them to achieve significant business growth in the long run.

5. Flexible pricing models

Flexible pricing models can significantly increase customer lifetime value (CLV) by allowing customers to choose pricing that meets their needs and usage limit. Here are three ways to structure your SaaS pricing:

1. Tiered pricing: This pricing model offers multiple plans to cater to customer segments, such as free, basic, premium, and enterprise. This encourages customers to start with an affordable plan and upgrade as they scale. 

2. Usage-based pricing: This pricing strategy allows customers to pay based on the product's usage, enhancing customer satisfaction and loyalty. 

3. Custom pricing: This pricing structure helps you address the specific needs of high-value clients. It will encourage repeat purchases, which increases your annual revenue and lifetime value. 

Analyze usage patterns and customer feedback to ensure your pricing support aligns with their needs and supports customer retention.

6. Create loyalty programs

Rewarding customers for their continued engagement is an effective strategy for improving customer loyalty. You can offer incentives like extra features, free months, or discounts on renewals. 

You must closely align loyalty programs and rewards with your product to ensure relevance and encourage customer satisfaction and retention. 

7. Target high-value customers early

To increase your CLV, target customers likely to make large purchases or show a lot of interest in your product. Attract high-value customers through referral programs, personalized offers, and excellent customer service. 

This approach makes your high-value customers feel valued, which boosts customer retention and increases customer lifetime value as you nurture your loyal customer base.

For example, HubSpot provides its high-value users personalized offers and exceptional customer service. These tailored marketing strategies help them to scale with their customer growth.

Real-World Example of CLV: HubSpot

HubSpot, a leading sales and marketing platform, operates on a subscription model. It offers a range of products, including CRM, marketing automation, content marketing software, and more. It provides a free tier and tiered paid plans ranging from $20/month to over $1500/month, depending on the product.

Consider ten customers who purchase the starter plan for HubSpot's marketing software, priced at $240 for two years. With an average gross margin of 84%, let's calculate HubSpot's Customer Lifetime Value (CLV) and the revenue they earned from each customer.

CLV Calculation:

CLV = ARPU × Customer Lifetime × Gross Margin

ARPU (Average Revenue Per User): The total revenue from 10 customers purchasing the starter plan is:

Total Revenue = 10 × 240 = 2400

The ARPU is the total revenue divided by the number of customers:

ARPU = 2400/10 = 240

Customer Lifetime: The customer's lifetime is 2 years.

Gross Margin: The gross margin is 84% or 0.84 in decimal form.

Now, applying the values to the CLV formula:

CLV = 240 × 2 × 0.84 = 403.20

So, one customer's Customer Lifetime Value (CLV) is $403.20.

Insights:

This means that each customer, on average, will generate $403.20 in profit over 2 years. As HubSpot's customers scale their business and see more excellent value, they will likely increase their spending, boosting the CLV further.

HubSpot implements strategies, including content marketing, paid ads, and referral programs, to retain more customers and enhance their customer experience. They also focus on customer retention through regular updates, dedicated customer support, and educational resources. These efforts enhance customer engagement, leading to higher retention and, ultimately, greater CLV.

A great example of improving customer lifetime value through providing resources to understand their product and services:

Measure and Boost Customer Lifetime Value

CLV is more than just a metric. It offers valuable insights into customer behavior and preferences. 

Analyzing your customer lifetime allows you to focus on improving customer experiences, building loyalty, and creating a mutually beneficial relationship that drives sustained growth and success. 

Maximizing customer lifetime value is crucial for your SaaS business. It allows you to refine retention strategies that encourage customers to stay longer with your business and contribute to revenue growth.

As a SaaS marketing agency, we will help you create tailored marketing strategies that boost your CLV and keep your customers happy.