If you are running a subscription-based business, whether your services target consumers or other businesses, there are several metrics to consider to better understand your performance and improve your chances of success.
Business metrics are quantifiable measures that track and assess processes and evaluate a company’s progression towards achieving long and short-term objectives. They are particularly important if you want to maximise your company’s potential.
Metrics can be applied in many ways. For example, sales teams monitor leads using lead generation and lead scoring. Marketing departments use metrics connected to the success of campaigns. But there’s one metric all companies should consider – that’s often misunderstood, under-utilised or even ignored – subscriber lifetime value (LTV).
In 2018, a study by Criteo on the state of customer lifetime value as a marketing metric found that only 34% of surveyed marketers were ‘completely aware of the term and its connotations’. Only 24% felt their company was monitoring it effectively.
In this guide, we explain what LTV is, why it’s under appreciated and how to calculate it for your business. We’ll also take a closer look at its relation to the cost of acquisition of a customer (CAC) and propensity models, and consider the link to retention and churn. These are essential concepts to monitor, for businesses that rely on recurring payments to sustain them.
What is Lifetime Value (LTV)?
Lifetime value, also known as LTV, is a metric businesses can use to measure the total revenue generated over the course of a subscriber’s lifecycle with that company.
The longer a consumer or client subscribes, the greater their lifetime value. So, it’s in every company’s best interest to try to retain subscribers for as long as possible, because there is a direct correlation with increased revenue from the customer over time. Plus, it’s cheaper to retain loyal customers than having to constantly find new ones. According to conversion rate experts Invesp, it costs businesses five times as much to attract a new customer than to keep an existing one.
So, why isn’t LTV considered more often? It’s of great benefit, as we’ll see, but there can be difficulties in understanding it, or focusing solely on it as a metric, which may be why some companies avoid it.
Wondering why you need to adopt LTV in your business planning? Here are just a few of the positive outcomes of considering LTV.
- It provides a longer-term perspective – Regularly thinking about customers throughout their lifetime as your customer will help you to become focused on investing in acquiring, nurturing and retaining to gain maximum value.
- The LTV equation can be applied to specific marketing channels – Determining LTV for search, email, ads and social means you can discover your most profitable channels. Know this and your marketing budget can be allocated to whichever brings the highest returns.
- Plan effectively – If a company can work out what its customers will spend in a specific time period, there’s a chance to properly plan for scalability.
- Better understand your customer base – Determining LTV can answer lots of questions to help you understand more about your customers or clients. You’ll discover how much a customer values your services.
As useful as LTV is as a metric, it doesn’t tell you everything. Focusing on it too much can have adverse effects. Here are some things to consider:
- LTV is only an indicator – As useful as LTV can be for your business, it doesn’t entirely represent the actual value of any one customer.
- Other metrics may be of greater benefit – For example, Average Order Value, or AOV, is particularly useful for subscription-based businesses. AOV tracks the average amount spent whenever a customer places an order online. AOV calculations are simple – total revenue is divided by number of orders. Increasing average order value is an effective way to drive direct revenue and increase profits.
Profit margin is another popular metric to gauge performance. Gross profit is a company’s total sales minus direct cost of selling a service. Net profit is how much is earned after subtracting operating expenses such as insurance from profit. These metrics may suit your business model better as a way of knowing how your company is performing.
- Remember, the future is unpredictable – LTV can help you plan your company’s future. But don’t forget, plans can change without warning and even with a strong formula and data, events can conspire against you. For example, few businesses were prepared for the financial crisis of 2008, or the pandemic in 2020. And what if your business model was to change? For example, if you swapped from large B2B clients to many smaller B2C clients, your LTV would drop. But that would be because your buyer persona has changed. You may be making more revenue and profit from lots of smaller accounts.
- People are as equally unpredictable – How can you truly know a customer’s LTV until they have stopped subscribing? This means LTV requires some educated guesswork. You can plan to keep the customer satisfied for as long as possible, but there's no way of determining for sure when they may stop.
- There are always variables to consider – LTV can be negatively impacted by various problems along the way. For example, a customer might love your product, but one poor customer service experience could lead them to leave. So, it can be a challenge to precisely determine what causes a customer or client to end the relationship.
The size of your customer base is important
Consider the size of your business. The LTV calculation has to be meaningful enough for it to have predictive value. It only becomes relevant when a company’s growth process is repeatable and scalable. The data that feeds into it needs to be instructive as to what future outcomes could be. A smaller customer base isn’t optimal for best results or usage of LTV. However, that’s not to say that it shouldn’t be considered ahead of time.
How to calculate LTV
The easiest way to calculate the lifetime value of a subscriber is with a simple equation:
The average value of a sale X the average number of repeat transactions X the average retention period for a customer (in years).
For example, if a subscriber to an online music streaming platform spends £15 every month for three years, the value of that customer would be:
£15 x 12 months x 3 years = £540 in total revenue (or £180 a year).
Customer Acquisition Cost (CAC)
Another important and popular metric in relation to LTV is the customer acquisition cost, or CAC for short. As the name suggests, this metric determines the resources a company needs to attract new customers, while continuing to grow. It’s essential if you want your business to expand its customer base and still make a profit.
CAC measures the cost of converting a possible lead into a customer. This metric is an excellent way to determine profitability because it measures and compares the amount spent attracting new customers against the number of customers or clients gained. If a company can reduce this value, it can spend more efficiently and look forward to higher returns in total profit.
How to calculate CAC
To calculate your CAC, and use it in combination with LTV, use this formula:
(Sales costs + marketing costs) / Number of new customers acquired through your activities
If the same music streaming service spent £30,000 on gaining new customers and acquired 1,000, their CAC is £30 each. This is good news in relation to their LTV. We’ll go into more detail about this later.
Propensity models can be used to predict specific behaviours of customers. Their use is wide-ranging. For example, they can identify who is likely to respond to a special offer. Or subscribers who could potentially churn (stop doing business, or cancel subscriptions).
In a podcast with Scott Howland of Zephr, Julian Thorne, CEO of The Big Wheel Consultancy, notes that understanding propensity is important in the world of digital newspapers. He points out that people who subscribe to email newsletters are more likely to subscribe to a digital edition of the newspaper than people who don’t.
Once a business grasps this concept, it knows how much time and money to put into developing its email newsletter strategy. By putting resources into the right areas of concern, CAC will decrease and LTV will increase.
Retention and Churn
Retention and churn are both key metrics when businesses want to better understand their subscription services and tie in their analysis with LTV and CAC.
Retention measures how many subscribers remain loyal to you. The metric checks who is continuing to subscribe and who is renewing when the time comes. As we’ve already noted, it’s much cheaper to retain customers than it is to find new ones.
Julian Thorne also notes that retention is the most important part of that journey and that first-time retention should be your top priority. After all, if you can’t retain a customer the first time around, you’re not going to achieve it the second time.
First impressions are key to high retention rates. If you can give a customer a first-rate welcome and onboarding process when they sign up, they won’t forget. Even if they’re tied in for a year before they can renew, this professional onboarding will stay with them.
You can calculate your retention rate in four steps:
- Note how many customers you have at the end of a given period, eg weekly, monthly, annually.
- Subtract the number of customers you acquired in that length of time.
- Divide by the number of customers you had at the beginning of that time period.
- Multiply that by 100.
So, let’s say a small business had 1,000 subscribers in December 2020. Within that month, it lost 200 subscribers, but gained 400. It’s retention rate for that period would be 80%.
Churn is the flip side to retention. Sometimes known as customer attrition, churn relates to the number of customers you lose, whether through cancelling a subscription or not choosing to renew.
While it would be nice to ignore churn, it’s inescapable and necessary to understand. Every business suffers churn to a certain degree. For example, an annual churn rate of 5-7% in the Software as a service (SaaS) industry is considered healthy. But if you have a higher rate and you can’t reduce it, alarm bells should be ringing. Churn is perhaps the best indicator that there’s a problem with your business.
To calculate your churn rate:
(Lost customers ÷ Total Customers at the Start of Time Period) x 100
If a company had 1,000 subscribers at the start of December 2020 and lost 200 within that period, it would have a churn rate of 20%.
The ideal lifetime value model
Although LTV can be tricky to evaluate, it’s an important metric that every company should learn to understand and calculate.
However, other metrics need to be considered too in relation to LTV. CAC, propensity models, retention and churn are all necessary to keep track of the successes and failures of your business. You can’t afford to do without them.
While there are many factors in keeping a company on the right track, all this can perhaps be boiled down to another calculation. The most important of all.
As a rule of thumb in business, the ideal lifetime value model is an LTV/CAC ratio of 3. This means the lifetime value of a customer should ideally be three times (or more) higher than the cost of acquiring them in the first place. If your ratio is closer to 1, or even less, you have a serious acquisition problem.
The music streaming platform we used as an example earlier made £180 in a year from a customer that cost £30 to acquire. It’s safe to say they’re doing well! Carry out these calculations yourself and learn just how well your business is doing.
To find out more about LTV, listen to Zephr’s podcast with Julian Thorne here.