Every business needs a stable base of customers. However, subscription businesses face the added challenge of continuously building ongoing customer relationships and maintaining strong engagement. While many companies measure their success with metrics like revenue, net profit and average order value (AOV), these don’t necessarily provide all the details that a subscription company needs to determine if its having success and its outlook is healthy.
For example, recurring revenue could be rising at a good rate every month. But hidden in this measurement is an unsustainably high churn rate that is being masked by a high acquisition rate.
Therefore, determining customer lifetime value (CLV) is an important tool for understanding your longer term revenue health. Specifically, it can offer insight on how you’re doing in terms of attracting the right customers and keeping them.
CLV is a calculation of how much revenue you can reasonably expect from each new subscriber that onboards based on your historical sales data. There are different approaches to calculating it, each with their strengths and weaknesses.
The simplest version of the formula looks like this:
CLV = (Average Order Value) × (Average Retention Rate) × (Number of Repeat Transactions)
In this case:
Average Order Value = (Total Sales) ÷ (Order Count)
Average Retention Rate = ((Total Customers - New Customers) ÷ (Old Total Customers)) × (100).
The solution to this formula will give you an overview of your current CLV. This can be useful for a number of reasons – it can help with revenue planning and any changes up or down can highlight improvements or declines in your overall subscription success. Your CLV can also allow you to segment your consumer base to see which customer referral paths are the most profitable so you can plan your acquisition and retention strategies accordingly.
Here’s an example of a simple CLV calculation:
|Average Customer Lifetime||5 Years||2 Years|
|Orders Per Year||4||6|
|Year 1 Revenue||$240||$480|
|Year 2 Revenue||$240||$480|
|Year 3 Revenue||$240||–––––––|
|Year 4 Revenue||$240||–––––––|
|Year 5 Revenue||$240||–––––––|
In this example, attracting a mid-range customer is more beneficial for the merchant from a revenue point of view even though the average order value and number of orders per year is less. This is because the amount of revenue that can be expected over the long-term is more.
This information lets you direct your acquisition resources to target the most profitable demographics for your business. However, what this calculation can’t tell you is whether the mid-tier customers are still more lucrative after costs are factored in.
While the above formula for CLV is the simplest, the complexities of others are there for good reason. More complex CLV formulas attempt to incorporate other factors that are relevant to a business’s bottom line. Here are a couple of other common ways to calculate CLV that incorporate costs.
Including the Weighted Average Cost of Capital (or WACC) means incorporating variables like debt and other financing costs. Investopedia provides a good guide for finding this number. Furthermore, if you segment between different product types you offer, you can find out which are yielding a better return. Also check out this post for more information on calculating churn rates.
CLV = Monthly Recurring Revenue / (%Churn + WACC)
Subtracting your cost of service (COS) from your monthly recurring revenue lets you factor in business expenses (like software licenses, hardware, hosting, maintenance and other overheads) so that you can get a sense of how your revenue compares with total costs per customer. If you include WACC as well, your formula is then:
CLV = (Monthly Recurring Revenue) x (1-%COS) / (%Churn + WACC)
There are plenty of ways to improve your CLV; you need to attract customers that are a good fit with your product and then keep them engaged over the long-term. The right formula for your particular company will be unique so be ready to test different strategies to acquire the right customers and keep them subscribed.