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The Ultimate Guide to SaaS Customer Lifetime Value LTV Customer Lifetime Value LTV is an estimate of the average gross revenue that a customer will generate before they churn cancel A basic LTV formula This basic formula for LTV is commonly accepted as a useful starting point for estimating the LTV of SaaS customers However it s only a rough estimate and doesn t properly account for Monthly Recurring Revenue MRR expansion contraction or the fact that churn doesn t occur linearly see pages 2 3 Your Product Activation Free Trial Customer Lifetime Buy 50 Renew 50 Renew X of months to examine Churn Renew LTV ARPA x 50 1 Customer churn rate n n 0 150 Lifetime Value A User This can be simpli ed to the following formula which will trend to the same result ARPA LTV Why should I care about LTV Primarily to apply a limit to your Customer Acquisition Cost CAC if you re spending more on acquisition than you anticipate to earn from the customer in revenue you re going to be in a bad place very soon unless you have a bottomless pot of money to spend on acquisition i Cust Churn Rate Important Make sure that both these values are from the time range for which you are measuring LTV ARPA aka ARPU ARPC Average Revenue Per Account in MRR For this guide we are only focussing on subscription revenue If you are a SaaS that has additional revenue such as setup fees metered charges or any other type of one time payment you will need to decide how to account for this

Customer churn rate and LTV Customer churn rate is the rate at which a business is losing customers due to cancellations proactive churn or failures to renew passive churn and is usually measured on a monthly basis How churn rate affects LTV One di culty with estimating LTV is factoring in customer churn rate The simple LTV formula assumes that churn happens linearly over the lifetime of a customer However this is never really the case in most real world scenarios What does your customer churn pattern look like Here are a few typical churn patterns presented by Tomasz Tunguz Annual Renewals churn fairly evenly over time with a larger churn at each contract renewal Cliff churn patterns have the majority of their churn within the rst month and then a small constant churn thereafter Constant is a steady constant churn rate shown here as 3 5 Declining demonstrates a churn rate starting at zero and increasing 0 25 each month Effect on LTV Percent of cohort remaining under 4 di erent churn patterns of Cohort Remaining 100 75 The Cli pattern results in 75 lower than the average LTV estimate suggests 1000 50 500 25 Month 0 3 6 9 Annual Renewals 12 15 Cli 18 21 24 27 Constant 30 33 Declining Source tomtunguz com churn fallacies 0 Annual Renewals Cli Constant Declining Source tomtunguz com churn fallacies Adjusting your LTV formula for varying churn patterns Other ways to account for varying churn in your LTV calculation If your customer churn contains a mixture of Annual Renewals Constant Declining and Cli patterns an easy way to adjust our simple LTV formula is to account for the variance by applying a discount Adopt a more advanced LTV estimation formula You can use statistical models such as Bayesian Probability which take a probabilistic approach to predicting LTV 2 ARPA Cust Churn Rate LTV x 0 75 Leads to a more conservative LTV estimate The Complete Guide to SaaS Lifetime Value LTV Calculate LTV per customer segment Di erent customer segments can have widely varying LTV It s a good idea to segment your customer base to get more meaningful results e g calculating LTV separately for customers paying monthly vs annually is highly recommended

Account expansion contraction and LTV Account expansion refers to any increase in recurring revenue after the initial purchase usually occurring from a plan upgrade Account contraction refers to any reduction in recurring revenue occurring after the initial purchase This could be due to a customer downgrading their plan or adding a discount Example How account expansion affects LTV Customer X is on a 100 monthly plan We expect them to churn after 1 year LTV 1200 Customer Y is also on a 100 monthly plan also expected to churn after 1 year But Customer Y upgrades their plan to a 150 monthly plan in month 4 and then again to a 180 plan in month 8 LTV 1800 Pretty significant difference LTV with expansion Expansion Expansion LTV without expansion Should I consider account expansion or contraction in my LTV formula Case Characteristics Formula B2C Usually expansion or contraction is less relevant with B2C products Most customers generally subscribe on a speci c plan and stay on that plan for the lifetime of their subscription Here we can simply use the standard formula B2B Your B2B business model doesn t involve signi cant expansion in MRR during the lifetime of a customer i e customers aren t likely to move to a higher tier ARPC No expansion LTV Cust Churn Rate Accounts for basic linear expansion B2B With expansion Your business model leads to a steady expansion in MRR for existing customers e g because you re billing per number of users ASP LTV Cust Churn Rate m 1 Churn Rate Cust Churn Rate 2 Note This addition proposed by David Skok accounts for some basic and consistent revenue expansion Here m is the monthly growth in ARPA per account We ve also replaced ARPA in the initial section of the formula with ASP Average Sale Price the average initial price in MRR that customers pay at the time of conversion Some precautions when calculating LTV In some scenarios estimating LTV may not be so useful for businesses with a small number of customers the estimated value is likely to uctuate from month to month due to the small sample size The LTV metric covered here only measures subscription revenue If your business has any other signi cant revenue such as one time payments setup fees or metered charges in your product you should think about accounting for these too 3 The Complete Guide to SaaS Lifetime Value LTV

Conclusion a modular LTV formula Here s the complete formula for Customer Lifetime Value with the optional components covered in previous pages you can add or remove them according to the characteristics of your business Our base LTV formula Add this to allow for some linear account expansion ARPA Customer Lifetime Value LTV 0 75 x Cust Churn Rate m 1 Cust Churn Rate Cust Churn Rate 2 Add this to compensate for variable churn for a more conservative LTV estimate ASP Also swap out the ARPA in the 1st part for ASP m the monthly growth in ARPA per account ASP Average Sale Price the average initial price in MRR that customers pay at the time of conversion 3 ways to use LTV So you have an estimate of your customer lifetime value that you re happy with based on the characteristics of your business How do you go about applying it in the situations where it s useful 1 Tracking your LTV to Customer Acquisition Cost ratio Look at your Customer Acquisition Cost How much on average are you spending to acquire a user According to Dave Kellog kellblog com if your LTV CAC ratio isn t 3 0 or higher you could be spending too much on customer acquisition 2 Evaluating your most valuable marketing channels Measuring LTV for each marketing channel can be a highly e ective way to prioritise those channels which acquire the most valuable users 3 Focus on retaining your most valuable customers Minimizing churn is a critical activity in any SaaS startup particularly through rapid growth Looking after the customers belonging to the segment with the highest average LTV could have a large impact on your ability to maintain MRR growth References We couldn t have produced this guide without the leading work of the following people Tomasz Tunguz http tomtunguz com churn fallacies Christoph Janz http theangelvc net David Skok http www forentrepreneurs com saas metrics 2 definitions Corey Pierson Custora http blog custora com 2011 08 why average retention rates can lead to 50 error in clv 4 The Complete Guide to SaaS Lifetime Value LTV chartmogul com support chartmogul com