We've looked at Unit Economics and now it's time to look into a big metric for SaaS businesses - Lifetime Value.
Lifetime Value doesn’t imply that you will keep all your customers for life. Each subscription will have a lifetime, and understanding how long this could be will help to forecast and see how your startup really makes money.
Lifetime Value is measured by customer and is a function of Average Revenue and the Customer Lifetime. This is often done on a monthly basis so Average Revenue will be your average monthly subscription and customer lifetime will be typically be in months.
Lifetime Value (LTV) = Average Revenue per Subscriber * Customer Lifetime
If there are consistent “blips” in the information you may want to smooth out monthly revenue by taking say the average of the last quarter.
Including revenue rather than profit per customer per month makes the calculation more focused on sales growth over any accounting profit figures. You could take margin, which subtracts the cost of serving customers to get a more accurate “payback” of customer acquisition costs.
Customer lifetime is a function of how historically subscribers have cancelled their subscription (or “Churned”). It is not a forecast or an estimate. For example, if you have 1000 subscribers and 10 left last month, then your monthly churn rate is 10/1000 = 1%
The customer churn can have a significant impact on calculating Lifetime Value. As you can see in the chart below, decreasing Churn by 1% lead to an increase in Lifetime Value of $833 per customer.
Putting into Action
- Business Planning is a great time to form some assumptions on what your business model looks like. Decide what metrics you’ll look to setup an efficient means of collecting them (i.e. a google doc).
- Keep stats monthly and review progress against your assumptions.
- Review one key metric each quarter, test its calculation basis, what should be included or excluded and really see if it's the right metric to track.
Further reading on SaaS metrics: http://www.forentrepreneurs.com/saas-metrics-2-definitions/
Disclaimer: Information provided to the best of the authors knowledge at time of publication. Laws are subject to change and independent advice should be sought before considering an investment decision. The above information is general in nature and should not be construed or relied on as a recommendation.