Behind the question of whether a billing system can help your SaaS business grow is the question of what it means for a SaaS business to grow. This guide tackles both — it creates a model you can use to approach SaaS growth and a 360-degree view of how your billing system fits into it. Read More >
There are lots of material about SAAS Metrics out there, but they all seem to jump a few steps ahead with certain assumptions.
Which made me wonder, why not build one from scratch.
Why is LTV (Life Time Value) so important to know? Unless you know how much money you are going to make off a customer you won’t know how much to spend to acquire them. We can try to pull numbers off air or based on approximations, but it really helps if there is a very simple way to know what it actually is.
Here is my first stab at deciphering LTV of a customer from a practitioner’s approach.
The amount of sales in dollars that a customer will spend with a particular company over their lifetime.
We are taking the following into consideration:
- A period of 12 months.
- Approximated average revenue from customer to $100. You should change this as appropriate to your business.
- Asking for percentage of churn is confusing. Instead I have taken actual number of customers who may leave month-on-month to come up with percentage using formula.
The recommended formula for LTV calculation is:
ARPU is the Average Revenue Per User
How long would it take to lose all the 121 customers at a 3% churn rate if you don’t add any new customers? This is also what (1 / percentage of annual churn) means.
But how do you know this is correct? We extrapolated the table above until the net customers reached 0 to verify this.
This is where we compared the obtained value through the formula and the lifetime value that we have calculated through the extrapolated table.
Interesting inference here is that the numbers from the original formula and the extrapolated data are not too far apart. At least the numbers are close enough that you can trust this to make business decisions like “how much can you spend to acquire new customers”.
Here is a sample spreadsheet to calculate the Lifetime Value of a customer. Please feel free to download the same and make changes to suit your business.
Here are a list of blogs for further reading on LTV:
- Chaotic flow: SaaS Customer Lifetime Value Drives SaaS Company Value
- For Entrepreneurs: On LTV
- ChargeBee: Customer LifeTime Value (CLTV) and its Importance.
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