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LTV For SaaS: Determining The Lifetime Value of Your SaaS Customers
Of All The SaaS Metrics - What Makes LTV (And The LTV:CAC Ratio) So Important?
The advanced world of SaaS marketing comes with some advanced metrics: starting with LTV (Lifetime Value) or CLTV (Customer Lifetime Value). But the real value creators know that these metrics only tell half the picture. You also need CAC (Customer Acquisition Costs). And if you really want to get into the weeds, you’ll start calculating your LTV:CAC ratio as well.
As far as SaaS metric acronyms go, LTV:CAC might be one of the biggest in the book. Why is that? Used properly, it helps marketers financially model their strategies with pinpoint accuracy and makes budget allocation that much easier.
We’ve all dealt with the frustrations of budget allocation. The truth is that most marketers aren’t satisfied leaving a budget meeting with a “no,” even if we’re given adequate explanation. We all want the power to convince our bosses to approve the budgets we need. But what we often lack is the ability to predict the actual, quantifiable change that our projects will create.
“It’s not that your boss doesn’t value your creativity or vision. It’s that they simply don’t have the statistical confidence in your strategy to put money behind it.”
And who can blame them? In today’s SaaS marketing world, there are countless campaigns that are running “successfully” across the board without generating any actual growth.
It’s about time we move past the old vanity metrics of Demand Generation and start looking at the numbers that really help us move the needle.
What is LTV (Lifetime Value) In SaaS?
LTV (or lifetime value) is an estimate of the average revenue that a customer will generate throughout their lifespan as a customer. Looking at this more holistic number when calculating customer value gives you a better picture of which clients and customer bases are truly worth prioritizing.
You calculate Lifetime Value using the following formula: [Average Order Value (monthly) X Gross Margin] / Average Customer Lifetime (months)
Analyzing LTV over simple order value or even average order value (AOV) may yield some surprising results that often show that the quicker wins are often the ones that don’t end up driving significant LTV. Which isn’t surprising given how LTV takes AOV into consideration.
“A customer’s lifetime value is necessary to understand if a business will succeed or fail.”
However, LTV is only one half of the crucial calculation in the true value of any SaaS brand’s customer. To truly understand which campaigns and strategies are driving real revenue and growth and which just look pretty, you need one more vital metric: CAC.
What Is CAC (Customer Acquisition Cost) In SaaS?
Knowing the actual value of any newly acquired customer is a great start. But to really understand if you’re moving forward or backwards, you need to know what it cost you to acquire that customer as well. Luckily there’s a nice and simple metric for you to calculate this already: Customer Acquisition Cost (CAC).
Customer Acquisition Cost is pretty straight forward. As the name implies, you add up the costs associated with acquiring new customers and then divide that amount by the number of customers you acquired.
Keep in mind that the costs associated with any given acquisition go beyond just ad spend – but should also include team costs, softwares, ad spend, and anything else you can attribute to the closed sale.
If you’re operating on a more account-based methodology you can do this on a one-by-one case. And you should also keep in mind to double check that any timeframes you’re using when calculating your CAC are comparable.
It’s no wonder that so many SaaS marketers cite Customer Acquisition as such a high priority (and pain point).
“86% of SaaS businesses treat “New Customer Acquisition” as their highest growth priority, both in terms of executive support and funding available.”
– Invisia
However, determining the true success of any channel, campaign, or strategy, is really dependent on a ratio between your LTV and CAC.
What Is The LTV:CAC Ratio?
LTV:CAC ratio is the calculation between your customer’s Lifetime Value and Acquisition Cost. Essentially, it’s a ratio that tells you how valuable your customers are and how much it costs you to get them to sign on the dotted line.
For obvious reasons, you want your value to be greater than your costs.
"The Customer Acquisition Cost (CAC), the cost of acquiring one new customer, for each segment should always be lower than the Lifetime Value of a new customer."
- Optimizely
You may have seen these letters popping up in the articles you’ve read lately. And why is it that there is so much literature on this topic? Why do SaaS marketers in particular sing the praises of the LTV/CAC?
Because LTV:CAC ratio is what tells the most accurate picture of where you’re generating value and – on the darker note – where you’re destroying it.
“If the LTV/CAC ratio is less than 1.0 the company is destroying value, and if the ratio is greater than 1.0, it may be creating value, but more analysis is required. Generally speaking, a ratio greater than 3.0 is considered “good” but that’s not necessarily the case.”
– CFI
The Golden Ratio For LTV:CAC
Now you may have noticed the number 3 in the above SME quote (and the following qualification).
But don’t worry, a 3:1 ratio isn’t some arbitrarily agreed upon number for SaaS marketing success.
What’s important to keep in mind with the 3:1 golden ratio is it’s what we choose to set as the baseline of success. That doesn’t mean it needs to be your end goal.
In fact, on the opposite end of the spectrum, if your LTV:CAC ratio gets above 10 it means that you might actually be leaving money on the table. So even in the higher instances, LTV:CAC enlightens you to when you should be scaling (whether you’re scaling up or down).
"The best SAAS businesses have a LTV to CAC ratio that is higher than 3, sometimes as high as 7 or 8"
- Invisia
LTV SaaS Guide: How To Calculate SaaS LTV:CAC
Now that we know the basic breakdown of the LTV:CAC ratio, let’s walk through a quick example of how to use LTV:CAC to calculate the success of a campaign and how to potentially improve it.
Company X has a monthly average order value of $7,000 and a gross margin of 63%. Its average customer lifespan is 16 months.
(7,000 * 63%) *16 = $70,560 LTV
On the other hand, the same Company X spends $100,000 per month and drive an average of 3 closed orders per month.
(100,000/3) = $ 33,334 CAC
Now that we have both numbers we can calculate the LTV:CAC ratio. Thankfully the math gets easier with each step:
70,560/33,334 = 2.1 LTV:CAC ratio
How Does LTV:CAC Aid in Determining Marketing Decisions?
Now that we have the LTV:CAC ratio of 2.1 we know that Company X isn’t destroying value with its’ campaigns. But it isn’t quite generating growth. So what can be done to improve the situation? This is where the nuances of LTV:CAC start to bring forth the insights that can empower your optimization decisions.
How? Simple – in a world of a seemingly infinite number of marketing campaigns and channels, prioritizing based on LTV:CAC is the best way to predictably scale your business.
Building your strategies and campaigns around LTV:CAC allows you to financially model out what budget is necessary to achieve statistical significance and success with any given tactic. It directly ties each strategic pivot back to revenue and new customers generated.
“For too long SaaS marketing strategies have focused on servicing the marketing department only through execution. B2B SaaS has moved on hitting email quotas and filling the funnel with nameless MQLS.”
To drive qualified customers and revenue, we don’t need widgets – we need winning strategies. Customer-led alignment leveraging LTV:CAC tailors your strategy to your customer segments for the most effective go-to-market approach. It uncovers what is working, and what can work harder. Each customer segment is optimized to better acquire, sell, and retain.
Using LTV:CAC To Determine Where To Allocate SaaS Marketing Funds
If you’re looking for some more practical applications of how to use your LTV:CAC ratio to allocate marketing funds for specific channels, look no further! We use the LTV:CAC calculator here at Directive to determine the success of any given business movement. So we figured it would only be fair to walk you through how to use it in the video below:
The truth is that the more marketing channels arise within this Post-Digital marketing world, the more picky we have to be as marketers when choosing which platform to use. It’s nice to think that if we show up everywhere, and on everything, all the time, that we will inevitably connect with our ideal end customer.
But even if that were the case, it’s far from a financially feasible growth model.
Just take a look at the graphic below and take a moment to consider: How many different channels and marketing campaigns are you currently running across how many tools?
It’s hard to believe that every branding touch in convoluted campaigns like these actually ties back to revenue. If we were painfully honest with ourselves, we’d have to admit that most of them are simply marketing touches for marketing’s sake. And as much as we all may hate to admit it, Facebook’s targeting isn’t as God-like as they’d like to admit.
Budget burn is a serious problem if you aren’t working with a clean TAM list – which makes identifying which audiences and channels work and (and which don’t) even more important.
How Demand Gen Forgot Their Promise
Demand Gen agencies may not want to tell you this – but MQLs don’t actually pay your bills or help your sales team out – SQLs do.
The truth is that your product/service isn’t for everyone. And that’s okay! It’s the lack of this basic recognition that leaves marketers blindly reliant on third party data for ad targeting which waste precious budget on needless impressions and empty clicks. The MQL is basically an unqualified lead with some very very basic exposure to your brand.
Why waste time and resources with marketing campaigns bent on filling up your sales team’s schedules with basically wasted calls?
“Demand Gen strategies that focus on MQLs categorically miss the mark because MQLs don’t predictably turn into revenue at scale.”
As a result of the legacy metrics of Demand Generation, there’s currently an ocean of hard working SaaS marketers dedicated to blindly optimizing their campaigns towards the wrong goals. And because of this, we marketers caught in the middle have been constantly fighting a losing battle of crafting winning MQL campaigns that don’t turn into revenue.
Which in turn leads to our boss questioning our effectiveness over efficiency. Which in turn leads to you getting tagged in your business as an execution/production marketer, instead of a value creator.
And guest what? The same goes for you if you’re an agency fighting for more budget with your client.
As opposed to constantly wasting marketer’s time, energy, and precious budget, building strategies focused on SQLs (leads that are actually qualified by a human salesperson), allows you to scale campaigns with confidence knowing that the leads you generate are tangible revenue opportunities.
Customer Generation And Scaling With LTV:CAC
LTV:CAC allows you to identify which campaigns and which audiences are actually generating value and growth for your business. It shows you where you can double down and what needs to be optimized/shut off with statistical confidence tied back to actual revenue.
And the better you can identify which levers to pull in order to scale consistently, the better you can grow your business with confidence and get back to doing what you set out to do – help more customers.
Isn’t it time you start looking for a better way to market your software/service? Something focused on what really matters from the very beginning: Generating Customers.
