Customer lifetime value (CLV) calculations have been around for a long time, used by huge enterprise organisations and tiny SaaS startups alike:
"CLV provides an estimate of the total revenue generated by an average customer over their entire lifetime."
The calculations range from the impractically complex, through to the uselessly simple, but even armed with a decent formula, there's a problem with most CLV calculations: they aren't SaaS-specific.
They fail to account for some of the unique quirks of the SaaS business model, and as a result, a ton of SaaS companies seriously under-estimate the lifetime value of their customers.
1) Up-Selling and Cross-Selling
With a strong product and a smart pricing strategy, it should be possible to up-sell and cross-sell a portion of your customers, moving them onto higher-priced packages, or adding additional product subscriptions.
As a result, the revenue you get from a customer in year one won't be the same as the revenue you get from them in year two, and year three.
For example, if a customer purchases a $1,000 a year license, for a period of 3 years, that's a CLV of $3000.
But what happens if they spend $500 to add another user to the license in year 2? Or they subscribe to an extra product in year 3, for an extra $250?
Factoring in this revenue, your CLV has grown by ~40%, from $3,000 to $4,250:
CLV = ($1,000 * 3) + ($500 * 2) + ($250) = $4,250
2) Customer Referrals
Most SaaS businesses will know to incorporate up-sell and cross-sell revenue into their calculations - but your customers can create value in less direct ways.
For example, customer referrals are an important channel of growth, capable of increasing your user base without any additional sales and marketing investment. Crucially, the revenue generated by these new customers can be attributed to the existing customers that referred them.
If, during the course of their lifetime, a third of your existing customers successfully refer a new customer, your lifetime value calculations need to be adjusted again:
CLV = $4,250 * 1.33 ≈ $5,666
Discover how customer referrals can impact SaaS growth:
How to Work Out Your SaaS Viral Coefficient (and Why You Should)
3) Job Changes
Customer advocacy can be an incredibly powerful tool. If an advocate of your service leaves one of your customers, Company A, and moves to Company B in a similar role, there's a great chance they'll repurchase your product.
You've earned another deal, but that deal has come as a result of your relationship with Company A - and the revenue generated by that sale can be attributed to the lifetime value of your original customer.
If we assume that 10% of your customers change companies, and repurchase your product, you need to adjust your CLV again:
CLV = $5,666 * 1.1 ≈ $6,233
As a result of overlooked revenue, we've doubled our CLV, from $3,000 to over $6,000.
The Importance of Customer Success
These are super simplified examples, but they're used to illustrate an important point.
Most SaaS businesses use CLV calculations as a benchmark for determining their sales and marketing investments. But by overlooking (or improperly attributing) these three sources of customer revenue, SaaS businesses chronically under-invest into sales and marketing, and limit their growth as a result:
"Understanding your CLV is important for determining a ceiling for your CAC (customer acquisition cost).
If you understate your CLV, you risk not growing fast enough, due to trying to keep your CAC too low.
Likewise, if you overstate your CLV, you risk burning through capital and acquiring customers which will never go on to generate a profit."
Even more importantly, by overlooking second order revenue from referrals and advocacy, SaaS businesses completely underestimate the importance of investing into customer success.
As we've seen, up-sells, cross-sells, referrals and advocacy can generate huge amounts of revenue. But for these channels to be successful, your SaaS business needs happy customers.
Your focus needs to move beyond leads generated, and deals secured: long-term customer success needs to be an equal priority.
