Customer Lifetime Value Explained: For Subscription-Based Businesses
For subscription businesses, the difference between those who succeed and those who fail is sustained optimal Customer Lifetime Value (CLV). This post will explain what CLV is and how it applies to your subscription business model.
What is Customer Lifetime Value?
We define CLV as: the average total revenue per customer, less the average variable costs per customer for a Cohort.
Measuring Customer Lifetime Value
There are two schools of thought, when it comes to measuring CLV. The first method is to measure CLV based on all historical data for a period of time. The second method is to measure all historical data for a period of time plus the expected revenues and costs in the future.
We strongly prefer to use the historical data as CLV and use the future projections to calculate something we call eCLV. Wrapping historical and future calculations into one CLV term falls short, in our opinion, because it fails to delineate what has actually occurred and what is “expected to occur.”
It’s also important to note what CLV isn’t. CLV is not the total revenues you got from a group of customers. That’s just total revenue per customer, but falls short of a true CLV calculation. CLV also is not total profit per customer, based on dividing company-wide profits by the total number of customers.
In the same way that total revenue per customer falls short of a true CLV calculation, total profit per customer includes too much by including overhead, admin, rent and other fixed costs.
Remember, the primary purpose of CLV is to measure the money you make incrementally for each customer. When done correctly it creates a powerful measurement tool for management, allowing you to focus on the areas where you can best lift CLV and overall company profits.
So what are the raw calculations for CLV is the average total revenue less the average variable costs for a Cohort?
Let’s start with a “cohort.”
A Cohort is a group of customers who share attributes. Those attributes are essentially infinite, but typically include a beginning date, a status of usage (trial, ongoing customer, cancelled customer, suspended customer, etc.), a specific product, a pricing plan and usually very important, where and how they signed up for a business’s product
Average total revenue per customer is the total revenue from a Cohort creates, divided by the number of customers in the Cohort. It’s important that all revenue is taken into account; revenue from trial fees, shipping, discounts as well as standard pricing should be measured.
Average Total Variable Costs per customer is the total variable, or incremental, cost incurred in selling a product, or providing a service, to a customer. Its important not to factor in to this calculation fixed costs or overhead amortization. Including those costs tends to distort the profitability of customers or traffic and pollutes it with factors not directly related to fulfilling customer needs.
As an example, a company selling a health supplement online would include their effective cost per acquisition of customers (eCPA), the cost to ship the product, the cost to bottle and produce the product (COGS) and the labor to get the product out the door. They would not include salaries of employees, other than those directly manufacturing or shipping the product or providing customer service, rent, legal, insurance or any other admin costs.
The combination of total revenues less total variable costs is often referred to in financial terms as Contribution Margin. By adding the total number of people in a Cohort, we can then break down the total Contribution Margin into an average Cohort CLV.
Example of Customer Lifetime Value in a Subscription Business
Spacely Space Sprockets signs up 10,000 customers, on February 1, for their “Sprocket-Of-The Month Club” service.
Customers signed up for an initial low price of $29.95 and then after 30 days they begin receiving monthly shipments of the sprockets, billed at $100 per sprocket.
Of the original 10,000 customers who signed up for the shipments, 5,500 are still live and receiving monthly shipments.
To date, they’ve received the following amount of revenue:
The following are the total costs associated with the Cohort after four months have elapsed:
|Total Costs||$ 985,000|
*Note this is ACTUAL CLV. The total expected CLV (eCLV) of this Cohort will be much higher because there are still 5,500 customers who have not cancelled.
Increasing Customer Lifetime Value Can Make or Break Your Business
Historically, businesses have used technologies and software focused predominantly on customer acquisition methods.
Customer acquisition strategies such as: search engine optimization, A/B testing, content and, email marketing, and social media have revolutionized sales and marketing over the last 15 years.
Recently, businesses are discovering that using software and technology to increase CLV is an area ripe for driving more profitability. The goal is often to refocus sales and marketing priorities, and lift advertising spend.
In the same way, a new wave of strategies and technologies focused on lifting the profitability of existing customers are now emerging.
Based on previous technology adoptions (such as A/B testing for customer acquisition), we are most likely approaching an inflection point where subscription businesses which actively test and optimize CLV using newer technologies will have a competitive advantage over less sophisticated merchants, allowing them to increase adspend (due to higher CLV) and grab additional marketshare.
In a subscription-based economy, it’s more important than ever to test and optimize customer service experience.
The first step to optimizing CLV is to understand and measure it.