How to Calculate the Lifetime Value (LTV) of a Customer
There are a few key numbers that are valuable to know as owners plan and make investment decisions. One of those is the LTV.
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There are a few key numbers that are extremely valuable to know as owners plan and make investment decisions. One of those is the “lifetime value of a customer” or LTV. It’s pretty simple to determine, so let’s step through the process.
No doubt your company has a wide range of recurring revenue amounts for different subscribers. Basic residential subscribers with no add-ons might be paying $25/month, while a large commercial account with an extensive system could be paying several hundred dollars. But for LTV, you really need to come up with an average.
If you have good security company software, you should be able to run a report to quickly get this number. Here is an example:
In this example, the average subscriber pays $47.77 per month. You could also add average service revenue from billable service calls to this, but for simplicity I’ll exclude it.
Subscriber Expenses
Next, review your direct expenses to support your subscribers. Here are some typical categories:
- Monitoring and interactive services fees
- Billing and collections costs
- Customer support costs
- Possibly some allocation of overhead
It’s best to take 3 to 6 months of financial data, and calculate the average monthly expenses. Some overhead expenses may be related to subscriber support, but it can be a challenge to determine exactly how much. So it may be best to just allocate a monthly dollar amount that captures what seems like a fair share of subscriber-related expenses.
In this example, lets say subscriber expenses add up (conveniently) to $22.77. Deducting that from your revenue leaves $25/month in margin per average subscriber.
How Long Your Customers Stay
Attrition will always be a key number for security alarm companies, partly because it helps establish average customer longevity. Low attrition means high longevity, and vice versa. Potential buyers love low attrition, because it means they can expect a nice long average life for the accounts they buy.
Again, high quality security industry software should make it easy for you to generate your attrition stats. Here is an example:
This shows growth rate, attrition rate, and net growth — monthly average, and annualized. So this company is experiencing 8.5% attrition, which is pretty typical for a custom installation company. To translate this into an average subscriber life, just divide 1 by this percentage…so 1 / .085 = 11.76 years. Then multiply 11.76 x 12 months in a year, and your subscribers stick around for about 141 months on average. That’s a long time!
Do the Math for LTV
Now it’s just a matter of some simple math, as follows:
How It Helps
This is very useful to know, because if you ALSO know what your average customer acquisition cost is, comparing the two numbers can help you with sales and marketing investments. On the expense side, know this number can also help if you’re evaluating investments in efficiency. Let’s say you’re evaluating a software platform — Cornerstone’s, for example — that will create efficiencies and allow you to trim your subscriber support expenses by $2/month.
In this example, the dealer has 1,873 subscriber accounts, so saving $2 each adds over $3,700 to monthly margin. It also increases the LTV of a subscriber by over $280. Likewise, if you have a customer issue, and you want to do something to save the customer — in light of a $3,500+ LTV you certainly have some leeway to offer some significant discounts or lower pricing to keep them happy.
LTV Compared to Recurring Revenue
In this industry, companies sell accounts typically as a multiple of recurring monthly revenue (RMR). Multiples paid range from 20 – 40x in most cases. What does this LTV mean in relationship to the $47+ RMR? Let’s divide $3,525 by $47+… the result is over 73x multiple!
However, this is a bit misleading, because the LTV looks at margin over nearly 12 years in this example. A dollar twelve years out is worth much less than a dollar today. So in terms of current dollars, the LTV is lower. A financial person would discount the future monthly margin by some factor to account for time and risk.
Scott MacDougal is the founder and CEO of Cornerstone Billing Solutions, a provider of alarm billing and payment services.
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