Get To Know Your Customers’ Lifetime Value
The subscription economy is fueled by recurring revenue. This means that customers need to stay subscribed long enough to cover their acquisition costs. It also means the longer they subscribe, the more money your business will bring in. The customer lifetime value (CLV) is the metric we use to make sure our subscribers are profitable. Let’s dig deeper.
Let’s use Netflix as an example, and work through the equation step-by-step.
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First, What Is CLV?CLV is the metric that businesses use to monitor their health. It forecasts the amount of subscription revenue earned before the customer "churns" or unsubscribes, making it particularly useful for balancing short-term and long-term marketing goals. It also provides a holistic sense of your subscriber’s behavior, and how service tiers and pricing affect the value of a potential subscriber.
Top Reasons to Monitor CLV
- Find high value customers
The nice thing about CLV is you can segment subscribers and dig into how each group is performing to see how promotions, demographics, subscription tiers and more, perform.
- Better allocate marketing budget
Find which customers are worth more to your business. Then see how your marketing efforts are performing.
- Build brand loyalty
If customers are loyal, they’ll subscribe for longer. CLV shows you if your recurring revenue is actually profitable.
How To Calculate CLVThere’s a lot of CLV content on the web, most of which is overly complicated. For something so simple, people often get too nuanced. When it comes down to it, you’re finding how much each customer is worth before churning, then multiplying by your Gross Margin. Gross Margin removes COGS (Cost of Goods Sold) to show a more accurate value.
- Find your churn rate. Let’s say that Netflix starts with 500 customers and loses 50 subscribers this year. We then divide 50 by 500 for a 10% churn rate. That means that every year, Netflix can expect 10% of customers to leave and stop paying.
- Calculate the average revenue per subscriber. Start by averaging the total amount of subscription revenue for that year. Using Netflix as our example, since 50 subscribers churned, 450 have paid the full amount this year. Let’s say that each subscription is worth $19.99 each month. 450 of our subscribers will then pay $19.99 each month, for a total of $107,946 this year. And 50 subscribers churned at month 6 for $5997 total. That makes our average revenue per subscriber (107946+5997)/500 = $227.89 for the year.
- Divide revenue by churn rate. 227.89/0.1 = $2,278. This number shows that each subscriber is worth $2,278 before they churn.
- Work in the expenses. Gross Margin is calculated using the following equation:
Gross Margin = (net sales – COGS) ÷ (net sales)
Gross Margin shows what percent of your profit is the cost of goods. As a streaming site, Netflix will have paid a massive amount in producing and licensing content. Let’s say the Gross Margin is around 40%, and let’s say that we spent $500,000 that year in advertising. Our CLV is then $911.2. Compared to the $1,000 acquisition costs per subscriber (500,000/500), Netflix is losing money. In order to be profitable, they need to decrease acquisition costs, raise the price of their service, or bring in more subscribers.
What’s Next?Now that you know how to calculate CLV, you can see if your subscription business is running smoothly. You can better monitor and identify potential revenue problems before they arise and plan accordingly. For more information on the metrics and strategies used to optimize marketing spend, check out our blog.
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