Updated: Jul 1, 2020
Customer Lifetime Value is a simple way to estimate the value of each additional customer you acquire. The beauty of CLV is it allows you to evaluate the performance of your marketing channels while giving you insight into the KPI’s that drive your company’s value.
You can use CLV to calculate the number of new customers a marketing or sales campaign must generate to break even. Because it’s so simple, CLV can conceal its assumptions about the future. You should understand those assumptions fully any time you calculate your CLV.
While it’s simple to calculate your CLV, calculating and monitoring the elements of your CLV is an ideal task for a business intelligence system.
Margin: Your margin is the difference between the revenue you receive per unit (e.g. one month’s subscription revenue) and the variable cost of delivering your product or service to one additional customer. Remember that this is only the additional cost of serving one more customer. Don’t include overhead. Also, don’t include sales costs, because you’re going to compare the CLV to the cost of customer acquisition later.
Churn Rate: Churn Rate is the percentage of customers who end their relationship with your service during a specific time period. The Churn Rate is arguably the single most important number for a subscription business. If you have 1,000 customers and lose 10 in a month, your Churn Rate for that month is 1%. You’re always going to have some churn, but managing churn through product improvements and customer service is a key to building a successful subscription business. We’re going to be writing more about churn in a future post.
Retention Rate: Retention Rate is the percentage of your customers who don’t cancel in a given period. It is simply 1 minus your Churn Rate. So, if your Churn Rate is 1%, then your Retention Rate is 99%.
Customer Lifetime: If you know your Churn Rate, you know your Customer Lifetime. Customer Lifetime is 1 divided by the Churn Rate. So, if your Churn Rate is 1% per month, your Customer Lifetime is 1/.01=100 months or a little over eight years.
Discount Rate: You’re unlikely to be able to get this number from your business intelligence system. It’s your cost of capital. If you have to borrow capital from the bank, it’s your interest rate. If you’re seeking investors, it’s going to be more difficult to determine your discount rate. The longer your customer lifetime, and you want it to be long, the more your discount rate matters. A decent rule of thumb for Discount Rate 10% per year, but you should consult your CFO or financial advisor for a more accurate number.
Churn is a key indicator for every SaaS business. You can’t manage it directly, but it shows up in other elements of your business. Customer satisfaction is a leading indicator of churn. Knowing your CLV will help you plan, monitor, and evaluate your marketing and sales initiatives. It will also help you chart the progress and success of your business. It helps determine whether you have a profitable, scalable business or need to reassess your entire strategy.
Understanding how each element contributes to your CLV helps you understand how your business works, identify trouble spots and improve your relationships with your customers.