It's rare to have a discussion about growth without the term customer lifetime value, or LTV for short, being brought up.
There's a good reason for this. Customer lifetime value is one of the few metrics which can either make or break a company.
Marketing budgets, revenue projections and a company's margins are all in some way or another derived from LTV.
If you're reading this post and know your company's fully blended LTV (more on the difference between fully blended and segmented LTV below) then congrats, you're on the right track. The problem is that if you're like the majority of startup founders blended LTV is all you've looked at.
There is more to LTV than meets the eye. In this post I'm going to go over some advanced LTV concepts and help you better understand your customers and business. I'm also going to share with you some ideas on how you can grow your customer lifetime value.
Not all customers are created equal and that's alright
The biggest issue with LTV is that most companies look at LTV as a fully blended metric only.
From a macro perspective, fully blended LTV is important. Your CFO and CMO will need to know this number in order to build their quarterly and annual plans. Your board and potential investors will also ask for this number. You want to know your fully blended LTV but that's not where you want to stop.
In addition to calculating LTV as an average across all their customers, you should also dig deeper and rerun the formula on specific customer segments.
Let's look at an example together to understand why this extra step is critical.
Let's assume that the fully blended lifetime value of our example company is $180. This means that on average, a customer pays us $180 during his lifetime as a customer.
When we look deeper we see that the company has three distinct customer segments.
When we analyze each segment we learn the following:
- LTV of Freelancers --> $75
- LTV of SMBS --> $150
- LTV of Enterprises --> $1,225
When we dig even deeper we learn the following:
- LTV of US freelancers --> $135
- LTV of non-US freelancers --> $68
- LTV of US SMBs --> $185
- LTV of non-US SMBs --> $144
- LTV of US Enterprises --> $2,550
- LTV of non-US Enterprises --> $2,115
We can go deeper and deeper until we have dissected the customer base into thinner and thinner slices. The deeper you can go, the more you'll learn about the make up of your customers and how they contribute to the business's bottom line.
If the CMO knows that customers from a specific industry or geography are worth more than the average customer then he can plan accordingly. Maybe the large advertising budget targeting freelancers in Far East Asia should be adjusted? Maybe a new marketing team targeting businesses on the West Coast should be formed?
Of course it all depends on the macro goals of the company and which numbers the company wants to influence. It might make sense to be inefficient in the short term in order to report higher growth figures six months down the road.
Product positioning, usage and what really influences customer lifetime value
I recently listened to a great talk given by Peter Thiel back in 2015 on the topic of competition. I've embedded the video below which I recommend you watch.
The biggest take away I got from the video is the way Peter summarizes business:
"A business creates X dollars of value and captures Y% of X.
X and Y are independent variables."
If you accept Peter Thiel's formula then we can focus on raising LTV by increasing X, increasing Y, or both. If we can increase these variables throughout the lifespan of the customer then even better.
Position the product to target a "better" customer
Value in monetary terms is relative.
A 1% improvement in operating margins for Amazon, is not the same as a 1% improvement in operating margins for the supermarket down the road.
The size of the business matters and one of the best ways to guarantee a higher customer lifetime value is to position your product to serve larger businesses.
You don't have to start out targeting mid-market or enterprise customers but you may want to consider adding features to your product which attract larger customers.
A pivot of the business so that it can be positioned differently is also an option, and not uncommon.
When it comes to license-based software businesses, where marginal costs are basically zero, the size of the average customer is going to be one of the most important variables in that business. SalesForce has a lot of room to grow within an organization with 1,000 employees compared to a business with 5.
Usage of your product is less important than you may think
If value is relative in monetary terms then the same can be said about usage of your product.
One business may use your product significantly less than another business but still consider your solution highly valuable.
Don't fixate too much on usage and instead work hard to understand the value your customers are gaining from your solution.
You may be surprised to find that one specific feature undervalued internally is the real reason people are paying you every month.
I'm always surprised to see in my client's data how little usage high value customers have. It's easy to forget that when a company reaches a certain size inefficiencies start creeping in and this includes paying for tools which little to no one is using.
For many businesses the health of the customer is what is really driving LTV
One of the most common issues that entrepreneurs, including myself, make is not clearly defining their target market.
In most cases the way the entrepreneur defines the target market is based on the sector or industry. On the surface this looks fine but we quickly forget that in every market the businesses in that market can be placed on many different spectrums.
An obvious spectrum is age. Some businesses in the market were started this year, some have been around for decades.
Often there is a variable or two which the target customer needs to have in order to take advantage of the value proposition your business offers.
The entrepreneur needs to define these variables in his target market definition.
Let's look at an example.
Let's say you have an app which helps eCommerce businesses increase their average cart size . Your app recommends complimentary products during the purchase process.
The target market for such an app are eCommerce businesses BUT only eCommerce businesses which have visitors going through the purchase process can receive value from your service.
The target market for this app's marketing team should be eCommerce businesses which have orders since this segmentation of the market can actually receive value from the solution.
Now it could be argued that eCommerce businesses with no orders can become businesses with orders. This is fine but then I recommend categorizing internally businesses that can, and businesses that can't yet receive value from your service.
It makes no sense to look at your usage, retention and other key product metrics across all your users if a portion of them can't even receive value from your service.
The LTV formula has two independent variables
Lifetime value can be calculated by taking the amount a customer pays you and multiplying it by the number of periods the customer pays you.
If we think about LTV this way we can manipulate different pieces of the formula to our advantage. These variables are:
- How much they pay for each period.
- How often they pay us.
Increase customer lifetime value by increasing your prices
I'm not going to spend a lot of time on this one since it's pretty obvious.
One of the best ways to increase customer lifetime value is by increasing your pricing. Of course you need to balance a price increase with your churn rate.
If you can get away with a 20% increase in your pricing with only a small increase in churn then there is a net gain for the business. Judging the impact of a price increase on churn is very tough and there is no magic way to calculate the change.
Below are some ideas for improving your confidence that your planned price increase won't kill your business.
- Talk to your customers: Try and get on the phone with 20+ long-term customers and get their thoughts on the value you bring and your current pricing. Ask them how they would feel if you increased your pricing in the next X months.
- Research the market: Perform a short market analysis to determine the costs of your competitors and alternatives to your solution. If you're significantly cheaper than the alternatives then a price increase is probably less risky than you think.
- Focus on top of funnel and improving your operational margin: The more you have coming into your sales pipeline the better you'll feel about raising your prices. If your customer acquisition cost is low and you have a healthy flow of new potential customers engaging with your business each week, your risk of ruin as a result of a price increase is low.
Move from monthly to annual payments
Another powerful way to increase customer lifetime value is by getting more customers to pay you upfront for a year.
If on average a customer paying you monthly pays 8 times, then every monthly paying customer that you switch to annual payments is increasing their LTV by 33% (4 additional months). You'll probably offer a discount for switching over to annual payments which will reduce the overall increase but in most cases it will be worth it.
Many B2B companies only offer annual payments which significantly helps their cash flow situation. An annual payment locks the customer in and gives the business more time to demonstrate value to the customer.
You don't have to start out offering only annual payments but you should strive to become the type of business where you can confidently move away from monthly payments.
Below are some ideas for getting more customers to pay you annually.
- Hire a UI/UX specialist to improve your pricing page: Don't discount the power of a well designed pricing page. A strong UI/UX specialist will be able to drive attention to the benefits of starting out on an annual plan vs. going with the monthly option.
- Use a tool like Intercom or Vero to send smart messaging to targeted customers: The customers most likely to upgrade to an annual subscription are customers receiving a ton of value from your solution. Use your customer data and a smart communication tool like Intercom or Vero to send the right email or popup to incentivize the user to switch.
- Find ways to save your customers money (and improve your cash flow): Services like Mixpanel, Segment, Mailchimp etc that offer scaling pricing have a unique opportunity to incentivize users to upgrade to a higher tiered plan, or annual subscription in order to save money. You might think this is a bad idea since it decreases LTV but this isn't necessarily true. It depends on your retention rate and account expansion metric.
Customer lifetime value is an important metric for every business.
Don't make the mistake of over simplifying how you analyze this metric and go as deep as you can.
LTV can be increased in a number of ways and I hope this post gave you some ideas on how you can improve this metric in your own business.
How important is LTV for your businesses and how do you measure and track this metric today? Let me know in the comments section below.