CLTV Isn’t The Whole Story. Don’t Shortchange Second-Order Revenue.

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Everyone in SaaS talks about CLTV (or LTV, same thing).  The lifetime value of your customer.  You can see a great detailed analysis of how to calculate it here.  And then, everyone goes on to calculate some magic metric telling you how much to spend on Sales and Marketing.  Usually some fraction (1/3 or so) of your CLTV.  Which usually equates to spending your first year ACV on acquiring your new customers.  Sounds fine, so long as you have capital to fund it.

I think the problem though is CLTV doesn’t go far enough.  Standard CLTV calculations don’t account for virality and second order customers.  So you may underinvest overall, or invest in fact too much in Sales and Marketing — and not enough in Customer Success.

Let’s figure out the Total Revenue Generated by {One Single Average} SaaS Customer Over its Lifetime:

  • Ok Sales closes its average Enterprise Customer A for $10,000 a year from a lead generated by Marketing.  Well done, guys.
  • Then, in Year 2, average Enterprise Customer A adds $2,500 in additional licenses, or $12,500 total on average for Year 2.  Some more, some less.  It typically averages out to 15-30% for more SaaS apps in Year 2 (averaged across all your customers) selling to medium sized and larger customers, net of churn.
  • Then in Year 3, average Enterprise Customer A adds another 25%, or $15,600 in Year 3.
  • So direct revenue over First Three Years = $38,125 from that One Sale.
  • And actually, most larger customers last longer than 3 years, but let’s stop there for now.

That’s the easy part to calculate, once you have a few months of data (maybe 18-24) under your belt.

But what about the second order effects?

  • At the end of Year 1, your champion quits Enterprise Customer A, but goes to Enterprise Customer B to do the Exact Same Job.  And buys your product again.
  • This happens about 10% of the time.
  • So that first sale is actually worth $42,000 (than first $38,000 above, x 110%).
  • But then it happens again in Year 2.  So it’s really $46,000.
  • And at the end of Year 1, your champion tells three of her friends about your company.  And one of them purchases.  About 30% of the time.
  • So that first sale is actually worth $60,000, adding in the second order effects (viral, word-of-mouth, champion job changes, etc.) — if you make your customers super duper happy.

Ok you can take this on and iterate it forever, I understand.

But my point here is standard first-order only CLTV analyses underestimate true revenue generated by customers by 50-100% in most SaaS models selling to anything larger than SMBs.

Put differently, your “all-in” CLTV, including second-order revenues and customers, is probably as much as 2x that of how you are calculating CLTV today.

So, sure, figure out the perfect ratio of Sales and Marketing expenditures to CLTV.  That will make your board slides pretty, and help you too.

But what you really want to do is figure out the perfect ratio of maximum possible investment in Sales, Marketing and Client/Customer Success — as one cohesive investment, not two.  All-in.  Because the second order effects compound.  They’re more profitable (no additional marketing or customer acquisition costs).  They build your brand.  And they fuel your growth.

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Second Order effects image from here.

There are 32 comments

  1. Bob Warfield

    If you’ve got a great product that customers love, that second order effect can be powerful. It gets multiplied in economic conditions where people are comfortable switching jobs and hampered when they cling to jobs in tough times. The loss of the second order is a double whammy for SaaS in tough times when it is also harder to sign new customers.

    Times is tough right now.

  2. Dave Key

    Great, thought provoking post.

    Referrals are a key aspect of building SaaS revenue, but then with the referral you get another Customer with their own Customer Lifetime Value. Your proposition is interesting; your CAC costs for a customer are really building your viral network of company promoters so you can justify a higher CAC. Your really just building longer term brand awareness by investing in a team of advocates that will go out and influence future sales.

    I consider the up-sell/cross-sell a hugely significant aspect of computing the Customer Lifetime Value. The CLV should increase over time as the subscription revenue from a company grows. The fixed subscription value in most CLV calculations ignoring up-sell/cross-sell is a significant limitation in most CLV calculations which I have discussed in a couple of posts: http://www.cloudstrategies.biz/dont-be-a-customer-lifetime-value-simpleton/ and http://www.cloudstrategies.biz/maximizing-revenue-for-saas-companies-is-more-than-customer-acquisition/

  3. Quora

    Why is it important for a business to have quality customer service?

    It may not be if you have an extremely mature product, and you are mainly competing on price and a purchased product. See, e.g., United Airlines. Comcast. Verizon. Hertz. These guys aren’t dummies. And they have the worst customer support imaginable.…

  4. Quora

    How do reduce the number of customer phone calls we’re getting?

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  5. In SaaS, As Long As You Are Growing 60% Or More — Your Competition Can’t Really Hurt You | saastr

    […] Second Order Revenue (Upgrades, Word-of-Mouth, Champion Change) Will Continue to Come In and Work, No Matter How Tough the Competition Is.  If you keep your customers happy, they’ll upgrade.  They’ll buy more.  They’ll tell their friends.  Even when your champions leave, and take jobs at other companies, they’ll bring you with them.  You don’t even have to be Better.  You just have to be Great, and make your customers heroes and a success.  More on Second Order Revenue (the key to SaaS economics) here. […]

  6. Maciek Gorzkowski

    Good post. SaaS 101. Treat your customers right then expect.

    Growth within.
    Growth when they leave and join elsewhere.
    Growth when they tell others.

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