SUBSCRIPTION FINANCE

How to Increase Lifetime Value for Subscription Businesses

As a subscription-based business, you know that acquiring new customers is essential to your success. But keeping (and continuing to sell to) your existing customers for as long as possible is just as important – don’t you think?

If you’re nodding your head yes (and you definitely should be), then you probably also know the importance of tracking and measuring the lifetime value (LTV) of your customers. And that’s great!

But if you want to really use this metric to your advantage, you need to also know how to answer questions like:

  • What are the 4 key factors to customer lifetime value?
  • How does knowing LTV help you make better business decisions?
  • What’s the best formula to calculate customer lifetime value for subscription-based businesses?
  • What are some things you can do to increase the lifetime value of a customer?

And, as you may have already guessed, those are the exact questions we’re going to answer in this blog post. But… before we begin, we have to make sure we’re all working with the same definition of LTV. So, let’s start there!

What Does LTV Mean?

Lifetime value, sometimes referred to as customer lifetime value (CLV or CLTV), measures how much profit you can expect to make from a customer throughout their time as a customer of your business.

Essentially, LTV tells you how valuable customers are to your business. And, as a subscription-based business, knowing this information can help you make important decisions with confidence.

Why LTV Matters for Subscription-Based Businesses

Lifetime value is an important metric for all businesses. But it is especially important for subscription-based businesses. Why?

Because, as you know, subscription businesses rely on recurring revenue models. And this means these types of businesses need loyal customers who will continue buying from them again and again. Tracking LTV is your way to ensure your business is retaining enough valuable customers to support long-term, sustainable growth.

Specifically, knowing LTV can help you do things like:

  • Predict future revenue and growth for your business: The higher the lifetime value of a customer, the more revenue growth you can expect.
  • Identify your most valuable customers: With this information, you can strengthen your customer retention strategies accordingly and target to acquire customers with similar qualities.
  • Determine the appropriate customer acquisition cost: For each of your customer segments, your customer acquisition costs should be lower than the LTV.
  • Make better, data-driven decisions on marketing campaigns: You can use LTV to determine where and how to best use marketing to acquire customers.
  • Identify issues related to your customer churn rate: By monitoring customer lifetime value, you may find issues with the customer experience that your customer support team can then address.

Of course, to access those benefits, you have to know how to calculate lifetime value for your customers. So, how do you do that? Good question!

We’ll share our preferred customer lifetime value formula soon and why we think it’s better than some of the other ways of calculating LTV (there are several). But, first, you need to know the 4 key factors of lifetime value for any of that to make sense.

4 Key Factors of Lifetime Value

The potential lifetime value of a customer comprises 4 key factors. And knowing each factor is essential to truly understand how much value this metric has when making business decisions. So, let’s look at each one.

1: Life Expectancy

Your customer life expectancy, or customer lifespan, is the average length of time a customer will spend money on your service.

To determine this, you’ll want to look at your customer data and see how long each customer spends with your company before they churn. Once you have this number, you can take the average. This will give you a good idea of how long you can expect a customer to stay with you.

Keep in mind that this number may change over time. So, you’ll want to regularly review and update your customer life expectancy.

2: Revenue Expectancy

The value you get from your customers depends on how much revenue you can expect from them. This number could be different for each customer, and it could also change over time.

To calculate it, you’ll need to look at your historical data and see how much revenue you currently have under contract. In your calculation, you’ll also need to estimate how much the revenue could change over time due to things like upsells and downsells.

Once you have this information, you can take the average value to get a good idea of how much revenue you can expect from each customer.

3: Cost Expectancy

Some businesses leave this factor out of their lifetime value calculation. But they definitely should not.

Cost expectancy refers to how much it costs you to deliver your product or service to your customers. For every subscription product your business offers, you need to estimate its contribution margin. The contribution margin represents the variable costs associated with providing your product and reflects the profitability of your subscription service.

4: Risk Expectancy

Some businesses also ignore this factor when calculating LTV. But, again, they definitely should not.

LTV is an estimate of customer value in the future. Risk expectancy makes that estimate stronger by considering the money you could potentially lose from your future revenue streams for a variety of reasons. And it’s because of risk expectancy that we recommend underestimating the lifetime value of your customers. Why?

Well, let’s imagine you overestimate the average customer lifetime value at $2,000 and then some unexpected occurrence (say, an economic downturn caused by a global pandemic) results in it actually being $1,400. 

Now let’s imagine that, based on the $2,000 estimate, you decided to set your customer acquisition cost at $1,700 per customer. Your overestimate would cost you $300 per customer instead of earning you $300.

How to Calculate LTV for Subscription Businesses

If you do a Google search, you’ll find several ways to calculate customer lifetime value. Some of those formulas include:

  • LTV = Monthly Recurring Revenue / Churn Rate
  • LTV = Average Revenue Per User x 1/Churn Rate
  • LTV = Customer Value x Average Customer Lifespan

BUT…

We wouldn’t recommend you use any of those LTV calculation formulas. Why?

Because none of them consider cost expectancy or risk expectancy. And that makes it possible that, by using those formulas, your lifetime value calculation will be an overestimate. And, as you can guess, that can be a nightmare for your business finances…

So, what formula should you use instead to calculate customer lifetime value? For a subscription-based company, we recommend this one:

Customer Lifetime Value ($) = Current Recurring Revenue ($) x Gross Profit Margin x Account Retention Rate / (1 + Discount Rate – Net MRR Retention)

For instance, let’s imagine you run a B2C monthly subscription business with the following metrics:

  • Monthly Recurring Revenue = $120,990
  • Gross Profit Margin = 85%
  • Monthly Customer Account Retention Rate = 70%
  • Discount Rate = 8%
  • Net MRR Retention Rate = 85%

Using those metrics, here’s how to calculate LTV:

  • Customer Lifetime Value ($) = $120,990 x 0.85 x 0.70 / (1 + 0.08 – 0.85) = $71,989 / 0.23 = $317,343

Note: You’ll likely need to do this customer lifetime value calculation more than once. Why? Because the LTV will differ among your various customer and/or pricing segments.

How to Increase Customer Lifetime Value

The best ways to increase customer lifetime value (without increasing your subscription price) are to reduce customer churn by improving the customer experience and increasing revenue from existing customers.

With those goals in mind, here are a few ideas on things you can do as a subscription-based business:

Start a customer referral program

A customer referral program has two major benefits. First, a customer referral program incentivizes your existing customers to promote your business. And, secondly, data on referral programs shows that referred customers are 18% more loyal, have a 16% higher lifetime value, and spend 13.2% more than non-referred customers!

Offer perks and rewards to your loyal customers

Your lifetime value calculation will tell you who your most valuable customers are. So, you’ll want to make sure that value is reciprocated! One way to do that is by offering those customers special perks and rewards for continuing to buy from your business. For example, you might offer early or discounted access to new features of your service.

Collect and respond to customer feedback

Knowing what your customers love about your business is nice. Knowing what they dislike about your business is even better because you can use that information to improve your business. So, regularly collecting customer feedback AND addressing problem areas is key to reducing churn.

For example, you can actively collect customer feedback by sending out customer satisfaction surveys and passively collect it by monitoring mentions of your company on social media platforms. Then, you create actionable plans to address major issues that might cause customers to cancel their subscriptions with your business.

Pay special attention to customers at the end of a billing cycle

Acting on customer feedback becomes even more important when you have customers approaching the end of a billing cycle. Soon, they’ll have to decide whether to renew their subscription. And you want to make sure they have no doubts about what decision they’ll make. 

To reduce churn with those customers, consider sending them personalized messages to ask how likely they are to resubscribe and what factors could influence their decision.

Increase customer spend by up-selling and cross-selling

You can increase how much your customers spend on your business by mastering the art of up-selling and cross-selling. Up-selling refers to offering customers a better version of your service for a higher price. Similarly, cross-selling refers to offering customers a complimentary service for an additional price.

For example, if you’re a SaaS company, you can up-sell by regularly marketing the additional benefits of your most premium plan to your existing customers. And you can cross-sell by creating and marketing valuable add-ons to your service.

Incentivize annual billing

As we just mentioned, any time your customers get to the end of a billing cycle they have to decide: to renew or not to renew? And, that’s a question that could negatively affect your customer lifetime value. How come? Because it could spark the end of the customer lifespan — especially if your customer is on a monthly contract.

To avoid this potential loss in recurring revenue, make your annual subscription plans as attractive as possible. Of course, it’s a good idea to offer a discount rate for annual plans. But you can also get creative by also offering things like exclusive access to valuable content from your business.

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