Customer lifetime value (CLV) is one of the most critical metrics used to evaluate a SaaS company’s financial health and to predict its future success. Unfortunately, it’s also one of the trickiest things to measure. Traditional business metrics fail to capture the key factors that drive SaaS performance. With revenue coming in over an extended period of time, the customer lifetime, it changes the way management, investors and potential acquirers determine whether the SaaS business is financially viable.
A happy and satisfied SaaS customer that continues to renew can return a considerable profit for the company. The sales team only has to acquire the customer once, and then through monthly recurring revenue and renewals the customer generates a profit over time. On the flip side, an unhappy customer who doesn’t renew could mean a monetary loss based on the cost of acquisition. SaaS businesses need to place emphasis on both acquisition and retention. And the customer lifetime value brings another unique angle to the metrics as it helps you estimate the projected total value of a customer over its lifetime.
A SaaS business must ask itself, “Is our CLV growing?” and “Are our customer acquisition costs in the right proportion to CLV?” The answers to these questions can help you scale the business to make money. They can also help you overcome common challenges in the SaaS business lifecycle. For example, emerging and growth SaaS businesses tend to have heavy upfront costs for customer acquisition. These usually taper off and balance out over time based on the profits from recurring revenue.
When a SaaS business grows rapidly, the losses and cash flow crunch can look very alarming on the financial statements, causing investors and board members to question business strategy. Sometimes, they advise SaaS companies to reduce acquisition costs and slow things down, right at the exact moment when ramping up is actually the smart thing to do. Eventually, after profits even out from monthly revenues, things get back in balance. But if you decide to increase sales and marketing efforts at this point, you could kick off another cycle of cash flow strain and apparent losses.
Even if your board and your investors were comfortable with this scenario the first time around, many of them will be extremely uncomfortable with the second dip in profitability from trying to accelerate the business…even if you think it’s the right thing to do.
The level of financial insight that you can obtain from QuickBooks and supporting spreadsheets is simply not rich enough to support sound decision making through these inevitable profit/cash flow squeezes. Were the business and CLV to be evaluated at the wrong time, it could mean the difference between receiving funding or completing a successful acquisition. The true health and longevity of a SaaS business depends on seeing the customer revenue stream over time, and having the ability to review other critical factors like acquisition costs, monthly recurring revenue (MRR) or annual recurring revenue (ARR), churn and retention rates.
You cannot expect a limited finance team to produce this level of analysis for each board meeting or funding opportunity without sacrificing a lot of time and effort from day-to-day accounting functions. If you’re using spreadsheets to track some of these metrics individually, it becomes even more time consuming and complex. Automated subscription management is key.
Before you can even calculate CLV, you have to start with accurate MRR and ARR. The more the customer base grows, the harder this becomes to track efficiently without an automated solution. The other aspect of CLV is churn (or the converse, retention). You need the ability to view churn in terms of dollars lost as well as actual customer logos lost.
With the right systems in place, you can add further operational insight with cohort analysis. What is happening with your customer base, according to any metric you care to assess—by date of acquisition, by contract type, by renewal period, by sales person? How are these cohorts performing over time? Are they growing or are they churning? By analyzing the data with these approaches, you can triangulate and detect patterns that will help you make informed decisions about resource allocation, pricing and packaging, contract structure, renewal rates and timing, sales compensation and more.
Calculating CLV is hard to do in the first place. But without automation, managing the data is nearly impossible. Give your business every advantage in a competitive marketplace by having the ability to automate revenue stream accounting by customer, and then gaining insight through MRR, ARR, customer acquisition and churn and retention rates. Then you will be in position to calculate the present value of your future customer contributions —the CLV—with confidence.