Are you looking to learn how to calculate LTV for your SaaS? Your search ends here - we’ve compiled all the necessary information to determine your average customer’s lifetime value.
This will prove invaluable along your journey to building and growing your company. It will help you determine what you’re able to spend to acquire new customers while remaining profitable. More importantly, it will help you determine just how viable your business is in the long run.
But that’s not all - today, we’re going to also empower you with tips on increasing your LTV if you find that it falls a bit short of your liking. We’ve got a lot to cover, so let’s dive in with a quick introduction to what it means to calculate LTV for a SaaS company.
What Does it Mean to Calculate LTV for SaaS?
Before we can teach you how to calculate LTV for SaaS companies, we need to discuss what this means in the first place. So - let’s first define LTV. This stands for lifetime value. And, it’s a key measure of how much a customer is worth to your business not just in the initial acquisition - but over the course of their life.
Think about it like this - your SaaS is likely subscription-based. That means month in and month out, each customer pays you for continued access to your software.
- A customer that sticks around for 3-5 years is obviously worth a lot more to you than a customer who tries your software for a few months and then bounces to something new.
- A prolonged customer association generally translates to heightened revenue. Contrarily, a brief association delineates a missed opportunity in terms of revenue generation.
Ultimately, figuring out what your average LTV is can help you assess what you’re able to spend to acquire each customer while remaining profitable.
Let’s expand this conversation a bit and talk about why calculating LTV is so essential for any SaaS company.
Why Learning How to Calculate LTV for SaaS Companies is so Important
There’s a reason this is one of the most important KPIs for any company - but especially a SaaS business. Below, we’ve highlighted the five reasons you need a solid grasp of what a customer will pay you over the course of your relationship with them:
- Predict future revenue: LTV allows you to predict how much revenue you can expect from each customer over the course of their relationship with your company. This is valuable information for forecasting future revenue and setting goals for your business.
- Optimize customer acquisition cost: By understanding your LTV, you can determine how much you can spend on acquiring new customers without going over budget. This helps you optimize your customer acquisition cost (CAC) and ensure that you're acquiring new customers profitably.
- Retain customers: A high LTV can be an indicator of customer satisfaction and loyalty. By focusing on increasing LTV, you can improve customer retention rates and reduce churn.
- Increase profitability: Ultimately, calculating LTV helps you increase profitability by ensuring that you're spending your resources (including marketing and sales budgets) efficiently. By maximizing LTV, you can increase revenue while also reducing costs, which can improve your bottom line.
- Attract investors: Investors often look at LTV when evaluating SaaS companies - and rightfully so. A high LTV can indicate a strong, sustainable business model, which can make your company more attractive to potential investors.
LTV is undoubtedly a key metric for any SaaS company looking to grow and remain profitable over the long term. By calculating LTV and using it to inform your business decisions, you can optimize your operations, increase customer satisfaction and loyalty, and drive revenue growth. But how do you do that? Keep reading - we’ll break it down for you in as simple terms as possible.
How to Calculate LTV for SaaS: Step-by-Step Guide
While learning how to calculate LTV for SaaS can be daunting at first, it doesn’t have to be. You don’t need a major in finance to figure it out. The formula is fairly straightforward. First - you need to figure out your average revenue per user.
Determine Your Average Revenue per User (ARPU)
This is the average amount of revenue you earn from a single customer in a given period of time (usually monthly or annually). To calculate this, simply divide your total revenue by the number of customers you have. Say your SaaS currently has 100 users and you want to know your ARPU (average revenue per user) in the last 30 days. You earned $50k in that period - so your ARPU is $500.
While this figure doesn’t account for users that are on different subscription plans, it’s a key starting point in calculating LTV. Next - you need to figure out how long those users typically stick around and remain loyal customers.
Calculate Your Customer Lifespan
Your customer lifespan is the length of time a typical customer stays with your company before churning (i.e., canceling their subscription or stopping their service). To calculate this, you can look at your historical customer data and see how long the average customer stays with you.
Obviously, this is trickier to figure out when your SaaS is a startup and you don’t have much information on this metric. And as with any KPI, the customer lifespan you land on is just a gauge - not the end all be all. With that said, let’s assume your customers tend to stay with your company for 12 months to keep things simple.
Calculate Your Customer Acquisition Cost (CAC)
The next step in calculating LTV is figuring out how much a customer costs to acquire - represented by CAC, or customer acquisition cost. Again - this will vary from conversion to conversion, month to month, etc. But getting a good sense of what you pay for a customer is the final step before you can actually calculate LTV for your SaaS.
To get this figure, you need to add up all of your marketing and sales expenses and divide that by the number of new customers you acquired in a given period of time. For example, let’s say your company spent $10k in the last 30 days to acquire 20 new customers - your CAC is $500. Simple enough, right? Now comes the fun part!
What is the Formula for Calculating LTV?
Interestingly enough, there are two formulas you can use to calculate LTV:
LTV = ARPU * Customer Lifespan
LTV = (ARPU * Customer Lifespan) - CAC
The first formula doesn’t take into account the cost of acquiring a customer - and so you may want to use the second formula to account for profitability. Either way, you can simply plug in the figures you’ve derived from the previous sections to your equation of choice to land at your LTV.
A Quick Example of Calculating LTV for a SaaS Company
Before wrapping up our explanation on how to calculate LTV for a SaaS company, we want to guide you through a quick example to show each step in greater clarity. We’ll use some of the figures we discussed above:
- ARPU: $500
- Customer lifetime: 12 months
- CAC: $500
By plugging these figures into the second equation above, here’s what we get:
LTV = (ARPU * Customer Lifespan) - CAC
LTV = ($500 * 12 months) - $500 = $5,500
Therefore, the LTV for this SaaS company is $5,500. Now - what do you do with this information?
I’ve Calculated LTV for My SaaS Company - Now What?
While you came here to learn how to calculate SaaS LTV, that’s actually just one piece of the puzzle. Now comes the perhaps more important step: interpreting it and making calculated decisions as a result of your findings. Before we do that, let’s talk about what a good LTV for a SaaS looks like.
What is a Good LTV for SaaS?
A good LTV for a SaaS company is typically one that is higher than the cost of acquiring a customer (CAC) and that can generate a healthy profit margin for the company. It’s that simple. But, your specific target LTV is dictated by your business model, target market, industry, and company goals. You need to ensure your LTV leaves you enough room to achieve growth plans.
As a rough benchmark, many SaaS companies aim for an LTV to CAC ratio of 3:1 or higher. This means that the lifetime value of a customer should be at least three times higher than the cost of acquiring that customer. However, the LTV to CAC ratio can vary depending on the business model and growth stage of the company.
How Can I Raise LTV for My SaaS Company?
Now - let’s say you have gotten this far and have discovered that the LTV for your SaaS company leaves a bit to be desired.
What are your options? There are several strategies you can implement to raise the LTV to a more satisfactory level, including:
- Improve Customer Retention: One of the most effective ways to increase LTV is to improve customer retention. Obviously, the longer you can bill a customer’s credit card the higher value they have in the long run. This can be achieved by providing exceptional customer service, proactively addressing customer concerns and complaints, and regularly engaging with customers to ensure they are getting the most out of your product. By keeping customers longer, you can increase the total revenue generated by each customer.
📚Read:Keeping Customers Happy
- Increase ARPU: Another way to increase LTV is to increase your average revenue per user (ARPU). This can be achieved by upselling or cross-selling additional features or products to existing customers, offering premium plans with more advanced features, or implementing price increases. This just comes down to offering more value to your users so you can command higher prices.
- Extend Customer Lifespan: Increasing the customer lifespan can also boost LTV. This can be achieved by offering longer-term contracts or annual billing options, providing incentives for customers to renew their subscriptions, or by creating an engaging customer experience that keeps customers coming back.
- Improve Sales and Marketing Efficiency: Reducing the cost of acquiring a customer (CAC) through improved sales and marketing efficiency can also increase LTV. This can be achieved by optimizing your sales and marketing channels, targeting the right audience with the right messaging, and improving your overall conversion rates
📚Read:SaaS Marketing Tactics
Ultimately, all this boils down to a few things: you need to make more money or spend less money. The techniques above all contribute to one or both of these goals. It’s up to you and your partners to determine which approach to improving LTV makes the most sense for your unique SaaS company.
The Importance of Calculating SaaS LTV
As you now know, this is a key metric in assessing the viability of your SaaS business in the long term. It helps you make more informed decisions with advertising and other customer acquisition costs. And, from an investors’ perspective, it’s a crucial metric.
By now, you should feel confident in how to calculate LTV for SaaS companies. But beyond finding a figure, you should be aware of how to interpret it and what your next steps should be once you’ve uncovered a figure.
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