Calculating Customer Lifetime Value for Digital Subscriptions


Calculating Customer Lifetime Value for Digital Subscriptions

In subscription and recurring revenue business models, maximizing customer lifetime value is a key success factor to a profitable business. Customer expansion and subscription extension are critical to customer success management. But how do you know when a customer relationship turns profitable? It is important to understand the point at which you breakeven on your investment in a customer relationship. This can be done using some of the industry standard operational metrics used in recurring revenue business models.

 

Standard Customer Lifetime Value Metrics

Here are some of the standard operational metrics that we use with our clients:

  • Customer Acquisition Ratio (CACR)
    The sales and marketing costs to sign up a new customer as a ratio to revenue acquired
  • Customer Renewal Cost Ratio (CRCR)
    The sales and marketing costs of closing a renewal as a ratio to revenue renewed
  • Research and Development Ratio (RD)
    The cost to invest in and make improvements to the service as a ratio to revenue
  • Gross Margins (GM)
    Revenues minus the costs associated with hosting a service and providing customer support
  • General and Administrative Ratio (GA)
    The cost associated with finance, management, and other functions as a ratio to revenue
  • Churn Rate(CR)
    The percentage of revenue not renewed at the end of a subscription term
  • Profit Margin (PM)
    The percentage of revenue that are profits
  • General and Administrative Ratio (GA)
    The cost associated with finance, management, and other functions as a ratio to revenue
  • Churn Rate (CR)
    The percentage of revenue not renewed at the end of a subscription term
  • Profit Margin (PM)
    The percentage of revenue that are profits

Using these operational numbers, the profitability of a customer relationship can be calculated as the total lifetime subscription revenue minus the total costs. The total subscription revenue would be the number of subscription terms multiplied by the subscription price, minus any churn. The total cost would be the customer acquisition costs, customer retention costs, and prorated G&A, R&D, and operational costs. Expressed as a calculation, it would appear as follows:

Customer Lifetime [CL] X Subscription Price

  Customer Acquisition Cost [CACR]

  Customer Retention Cost [CRCR] X Customer Lifetime

  (1 Gross Margins) X Customer Lifetime

  General & Administrative Costs [GA] X Customer Lifetime

  Research & Development Costs [RD] X Customer Lifetime

  Churn Rate X Subscription Price (Customer Lifetime 1)

=  Profit

As demonstrated by the calculation, the total number of terms (i.e. CL, or customer lifetime) is critical to profitability. The equation can be turned into operational metrics by dividing by subscription price to create ratios of each cost in relation to revenues. The result is the following equation:

Customer Lifetime

  CACR

  CRCR (1 GM) GA RD X Customer Lifetime

  CR X ( Customer Lifetime 1)

=  Profit Margin

Solving the average customer lifetime to the breakeven point can be done using the following equation:

  (PM + CACR CR)

  ÷ (1 CRCR (1 GM) GA RD CR)

=  Customer Lifetime

At breakeven, profit margin (PM) equals zero, which allows the equation to be solved.

The Implication
Knowing your breakeven point on customer relationships enables you to identify the source of profits. You can segment customers quickly into profitable and unprofitable categories. With that segmentation, you can identify what drives profitability and what are leading indicators of churn. In other words, you can optimize customer lifetime value and your revenues and profits. Use our “Revenue Lifecycle Calculator” to determine how much more recurring revenue you could be driving.



Authored by Michele Ballinger, Solution Marketing for ServiceSource.
In her role, Michele provides market insights and best practice advice to customers.
When she is not writing, you can find her hiking and photographing the breathtaking
Pacific Northwest.