Generally, the health of a SaaS business can be determined by two metrics: Customer Acquisition Cost (CAC) and Customer LifeTime Value (CLTV). While there are other metrics such as CMRR, ASC, Churn Rate and others that matter, you should be spending most of your time monitoring the CAC and CLTV. In this article, we look at the CLTV in details and why it is important to get your numbers right with it from the beginning.
CLTV (Customer LifeTime Value) refers to the amount of revenues that you expect to generate from a customer during the period over which your service will be of value. For example, if a customer signs up for your product for duration of 9 months, the amount that he will pay during the period will determine the life time value.
In discussing CLTV, the CAC (Customer Acquisition Cost) also comes into play. In simple terms, the CAC refers to the amount you use to acquire customers.
Generally, for your SaaS company to be profitable, it must operate within this formula:
CAC < CLTV
i.e. the cost of acquiring customers should be lower than the revenues that will be derived from the customers during the period when they will be subscribed to your service. The math seems elementary but if you miss the implications, your SaaS company will struggle to generate profits in the long run.
Let us look at how these two SaaS metrics relate to each other.
The Importance of the CLTV
In the SaaS industry, the general notion is that companies spend 5 to 7 times more in acquiring customers than the amount they spend on retaining existing customers. Customer acquisition is generally easy, but after it comes the problem of customer retention.
Most SaaS companies miss the mark by spending most of their resources and executive attention on growth through new customers while failing to keep the existing customers happy. In other words, the companies are not taking measures to keep their churn rate at a minimum. If you are not watching your churn, your business ship is leaking and sooner or later, it will sink.
To ensure your business stays on the course to profitability, you can either reduce the CAC or increase the CLTV. Below, we will focus on how to increase the CLTV
Breaking Down the CLTV
The basic formula of calculating the CLTV is:
CLTV = ARPU * Gross Margin * Lifetime
NB: The ARPU is the Average Revenue Per User.
The Gross Margin is the ratio of the total Revenue to the Cost of Goods Sold (COGS)-cost of providing services
Gross Margin (%) = (Revenue- COGS) / Revenue
To improve your gross margins, you must find ways to keep the COGS stable or shrink it as your revenue grows. The lower your COGS is, the more the revenue you will realize. From the CLTV equation, it is clear that to grow your CLTV, the ARPU and Gross Margin values should also grow.
To grow the lifetime value, invest in lowering your churn rate. This means focusing more on customer service and responsiveness.
Average Revenue Per User
To improve the ARPU, focus on upselling your service to your users. This means using efficient ways to make your existing customers purchase more, be it through discounts or coupons on upgrades.
To lower the COGS, you must have effective and efficient service operations. This means having a robust mentoring and alerts infrastructure.
Monitoring the two discussed SaaS metrics will help you know the health of your business and therefore know the steps to take to improve profits.