How to Calculate, Interpret & Improve SaaS LTV

Originally published on August 5, 2022

SaaS LTV, or Software as a Service lifetime value, is a metric that tells you how much money a customer has spent on your SaaS product during their entire time with your company. It’s an insightful metric for understanding which users provide the most value to your business and is particularly useful if you’re investing in product-led growth. SaaS LTV is easy to calculate using a variety of formulas.

LTV explained

Lifetime value (LTV) is the total amount of money a customer spends during the customer’s entire relationship with your business.

If the customer spends $500 a month on your SaaS product and stays with your business for 12 months before moving on to another product, the customer’s lifetime value would be $500 * 12 = $6,000.

Why is LTV important?

LTV tells you what the entire customer relationship is worth to your business. The longer a customer stays with your business, the higher the LTV and, therefore, the higher the worth of that relationship to your business.

Businesses calculate LTV for financial forecasting as it helps them predict the revenue they will get. It’s also used to inform business strategy and resource allocation.

For example, by calculating LTV, you can figure out which customer segments have the highest LTV so you can focus on retaining them. Maybe customers with low-profit margins stay longer and generate more revenue over time, while those with high-profit margins don’t stick around very long and are not lucrative to your business.

Similarly, if a particular marketing channel brings in high-LTV customers, allocating more budget to that channel makes sense.

What’s the difference between LTV and CLV?

Lifetime value (LTV) and Customer lifetime value (CLV) are often used interchangeably but have slightly different meanings. LTV shows the total amount that all customers will bring in over the time they interact with your company. It provides a big-picture view of the overall revenue potential from the entire customer base. CLV shows how much a single customer will bring in over the time they interact with your company and focuses on individual customers.

Why is LTV in SaaS so important vs. non-SaaS companies?

SaaS (Software as a Service) is software hosted online and accessed through a subscription rather than a one-time purchase. A high LTV contributes significantly to a SaaS company’s profitability because it’s nearly impossible to recover the investment in acquiring new customers from a one-time purchase.

Let’s say a SaaS company spends $100 to acquire a customer who pays $10 per month. It would take ten months just to break even. If this customer stays for several years, the company can generate significant profit. However, if the customer leaves after a few months, the initial acquisition cost outweighs the revenue gained.

In contrast, non-SaaS businesses often have a revenue model based around immediate, one-time sales and don’t depend on retaining customers over a long period as much as SaaS brands. Metrics like average transaction value and immediate ROI from marketing efforts are more relevant.

How to calculate LTV for SaaS

There are a few different ways of calculating LTV for SaaS businesses:

Method 1: Simple formula

Use this method when you need a quick and straightforward calculation and clearly understand the average revenue per customer and average customer lifespan.

LTV = Average Revenue Per Customer * Customer Lifetime

For example, if a customer spends $50 a month on your SaaS product and stays with your business for six months on average, the LTV is $50 * 6 months = $300.

Method 2: Churn rate formula

Use this method when you have data on customer churn rates and want to understand how customer retention impacts LTV. Churn rate is the percentage of subscribers who canceled their subscriptions during a specific period. For example, if you had 200 subscribers in the previous year and lost 10, the churn rate is 5%. The higher the customer churn rate, the lower the lifetime value.

LTV = Average Revenue Per Customer / Churn Rate

If the average revenue per customer is $50, and the churn rate is 5%, then the LTV is $50 / 0.05 = $1,000.

Method 3: Gross margin formula

This formula helps you see the LTV in terms of gross margin rather than revenue. It provides a clearer picture of actual profitability because it considers the costs associated with generating revenue. Understanding the true economic value of your customer base helps you make more informed decisions on customer acquisition and retention strategies.

LTV = (Average Revenue Per Customer * Gross Margin %) / Revenue Churn Rate

The variables in this equation are:

• Average Revenue Per Customer = MRR (Monthly Recurring Revenue) / Total Number of Accounts
• Gross Margin = Total Revenue – Cost of Goods
• Revenue Churn Rate = (Revenue Lost in a Specific Period – Upsells in that Specific Period) / Revenue at the Beginning of the Period

If the average revenue per customer is $50, the gross margin is 10%, and the revenue churn rate is 5%, the LTV would be ($50 * 0.10) / 0.05 = $100.

Method 4: Analytics chart

Use this method if you have access to an analytics tool. With Amplitude’s Revenue LTV chart, you can easily find SaaS LTV, identify trends, and share insights.

For example, the chart below shows that on day 30, LTV was $1,883, and there was a large dip in LTV around day 52 before spiking up again at the end of the 60 days.

Investigate your SaaS LTV by getting started with Amplitude for free.

SaaS LTV to CAC ratio

CAC stands for customer acquisition cost and measures how much you spend to acquire a new customer for your SaaS business. The LTV: CAC ratio measures the relationship between a customer’s lifetime value and the cost of acquiring that customer.

Your company will be more profitable if your SaaS LTV is high and your CAC is low. For example, if your CAC is $100, and the same customer’s LTV is $1,000, you’re essentially profiting $900 from that customer.

A popular benchmark for a good LTV to CAC ratio is above 3:1 but below 5:1. A 1:1 ratio means you spend more than the revenue you bring in from customers. If your ratio isn’t above 3, you’re spending too much on customer acquisition, or you’re unable to retain your customers over time. If your ratio is too high, you are likely under-spending on marketing and limiting growth.

To calculate CAC, the formula is:

Total Amount of Marketing and Sales Expenses / Number of Customers Acquired in a Given Period

If you spent $20,000 on marketing and sales and acquired 500 customers over a two-year period, your CAC is $40.

The LTV to CAC ratio helps inform SaaS business decisions like:

• Which type of customer is the most profitable to acquire?
• How much should I invest to acquire a given type of customer?
• How many sales reps should I hire to acquire customers?

Metrics that impact SaaS LTV

Several key metrics ladder up to the LTV of a SaaS product. Understanding and improving these metrics will help you maximize customer value.

• Monthly Recurring Revenue (MRR): This is the revenue a company expects monthly from its subscribers. Higher MRR indicates more revenue per customer, directly increasing LTV.
• Average Revenue Per User (ARPU): ARPU measures the average revenue generated per user over a specific period. Higher ARPU signifies more income per customer, thereby raising the LTV.
• Number of Accounts: This refers to the total number of active customers or subscriptions. More accounts typically mean more revenue, which can boost the overall LTV if retention rates are high.
• Churn Rate: The churn rate is the percentage of customers who cancel their subscriptions during a specific period. A lower churn rate means customers stay longer, increasing the LTV.
• Product Stickiness: This metric gauges how frequently and consistently customers use a product. High product stickiness often leads to better customer retention and increased LTV, as satisfied customers are less likely to churn.

3 ways to improve SaaS LTV

Once you’ve calculated the LTV for your business, there are several ways to increase LTV.

1. Boost the metrics that impact SaaS LTV

Improving the metrics that feed into LTV will help to improve LTV and boost the profitability of your SaaS product.

Example: Increase ARPU

Increasing the average revenue per user (ARPU) directly raises LTV. To achieve this, consider periodically increasing your prices. Explore and test your pricing structure to determine what your users are willing to pay. Additionally, you can grow revenue from existing customers by upselling, cross-selling, or upgrading them to higher pricing plans.

Laura Granahan, Principal Customer Success Manager at Amplitude, explains that she uses the Amplitude platform to identify upsell opportunities by checking feature usage. “Say I notice a group of users on an account who are exceeding their maximum number of free syncs and hitting a paywall. I can use that information to let the company know there is a segment of users on their account who would get value from a higher-tier plan,” explains Laura.

Example: Reduce churn

One way to increase LTV is to extend the customer lifetime, which can only happen by reducing churn. You can reduce churn by rewarding customer loyalty, offering top-tier customer support, and enabling customers with educational resources and training. Helping customers become proficient users of your SaaS product will keep them engaged and retained.

Calculating customer churn provides a starting point for investigating why customers cancel their subscriptions. You can identify and address the root causes of churn by analyzing customer feedback and usage patterns. For example, solving product issues causing customers to leave or offering new content and features can help retain them. Once you have a hypothesis, you can A/B test it and take steps to prevent further churn. In the meantime, continue listening to your customers and serving their needs.

Learn how to calculate and analyze churn.

2. Analyze LTV by customer cohorts

You can use SaaS cohort analysis to determine where and how to optimize your acquisition efforts by breaking your customers into cohorts or segments. For example, customers using macOS are more likely to continue using your product over long periods since your product is more compatible with macOS than Windows. From there, you might focus your acquisition efforts on MacOS users or work on improving the product experience for Windows users to help retain them longer.

You can also use behavioral cohorts to analyze groups of customers based on their behaviors in your SaaS product. For example, the Amplitude chart below compares LTV in a B2B SaaS messaging app for users who joined a channel and those who did not. Those who join a channel have higher SaaS LTV, so it would benefit your business to surface the join channel feature during onboarding.

Users who joined a channel (green) have higher SaaS LTV than those who did not (purple). Try creating this chart yourself in our self-service demo.

3. Understand high LTV customers through interviews and analytics

Identify customers with a high SaaS LTV since they are the ones who have likely been with your business for a long time. Interview customers to ask why they’ve stayed so long and what would make them want to continue using your product. An analytics tool will help you learn which product features are most popular and your best marketing channels to connect with high LTV customers.

Find out the LTV for your SaaS business today by getting started with a free Amplitude account.

References

• 2024 State of SaaS: Trends and Predictions with SaaStr CEO and Founder, Jason Lemkin. SaaStr
• Startup Study 2023 (LatAm Digital Report). McKinsey
• What It Takes For A SaaS Startup To Scale From $1 To $5 Mn? Inc4