KPI Series Part 4: Dig Deep to Discover Customer Lifetime and Customer Lifetime Value
Along with customer acquisition costs, customer lifetime and customer lifetime value (CLTV) tend to be two of the other most commonly monitored key performance indicators for all businesses. Customer lifetime represents the number of periods an average customer remains on a company’s platform, paying for and utilizing a product / service. Hand in hand with customer lifetime, CLTV represents the cumulative economic value a customer provides to a company over its average lifetime using the company’s products / services. These two metrics are essential to consistently track, as they provide a granular understanding of how valuable customers can be over their average lifetime.
Generating Customer Lifetime to Understand Customer Dynamics
As mentioned, customer lifetime is representative of the average length of time that a customer pays for and uses a company’s product / service. This metric provides business owners and investors useful insight into how long customers remain with a company, as well as the economic viability (or unviability…) the current customer base provides to the company. Customer lifetime can be stated on a monthly, quarterly and/or annual basis, which gives companies the ability to present the KPI over the period that best aligns with their desired positioning and business model. Although companies can present a customer lifetime calculation for its entire customer base, it is typically a best practice to refine the calculation by presenting it by specific customer subsets / cohorts. This allows the company to remove the impact of anomalies or outliers among a portion of its customer base that may erroneously affect the total calculation (e.g. smaller SMB customers having a lower ARR and churning more than larger, enterprise customers, thus possessing a lower total customer lifetime). Below provides a representative calculation and example for customer lifetime:
Taking the Next Step in Reporting with Customer Lifetime Value
Although customer lifetime is an important metric in and of itself, CLTV helps provides more detail about customers that a company can utilize to improve its reporting and performance planning. There are a number of nuances that can go into the calculation of customer lifetime value. These include representative items, such as presenting the figure with / without the impact of gross margin, utilizing annual recurring revenue vs. expected cash flows from customers over their lifetime in the calculation, and presenting it as a discounted, net present value to be generated from customers. Additionally, much like customer lifetime, CLTV can be calculated as a total blended figure across the entire customer base or can be calculated over select customer cohorts to further refine the presentation of the number. As is stated in other articles in the KPI Series, it is recommended that business owners and investors use whichever definition they feel most comfortable presenting, as long as the CLTV calculation remains as simple, consistent and transparent as possible throughout the reporting and performance planning process. In the example below, I have opted to use one of the more simplified versions of the CLTV calculation to provide a representative formula that a wider array of readers can understand and utilize:
Concluding Thoughts: Making Sense of the Lifetime and Lifetime Value of Your Customer Base
KPIs that provide more detail on the unit economics of a company’s customer base are helpful for business owners and investors alike, as they help depict how valuable customers currently are vs. how valuable they could be with improvements in retention rates and/or increases in average ARR sold to customers. It is also essential for internal sales, customer success and finance teams to collectively grasp customer lifetime and CLTV, so that they make the necessary adjustments to other strategic and operational activities that can help extract full value from customers over their lifetime. Through consistent monitoring of these key metrics, companies improve their reporting mechanisms, allowing for better preparation and presentation of financial information to all internal and external stakeholders.