In every industry, companies are moving away from traditional revenue models and shifting towards strategies that are centered around recurring revenue and subscriptions. By removing large investments associated with perpetual licensing, these businesses have reduced switching costs for customers, especially in the B2B space.
At my organization, we've found that a subscription price model can be a great way for companies to lock in recurring revenue. That's because this approach grows customer lifetime value (LTV) which increases profit for businesses over time.
In this post, let's explain the fundamentals of growing customer lifetime value, then we'll provide some best practices you can use to increase LTV at your business.
How to Grow Customer Lifetime Value
Growing LTV means improving your relationship with the average customer, and it's built on three cornerstones.
1. Upselling and Cross-Selling
A key driver of LTV is the ability to upsell customers on premium subscriptions or cross-sell them on additional products that fit their needs. Your basic-level products shouldn't give away all of your value upfront, creating a path for you to upsell and cross-sell over time.
2. Expanding Product Usage
Product usage can also be an LTV driver if you have the right licensing and price model to capture the value of increased usage. Ways of driving usage include acquiring more users, expanding to adjacent departments, and installing or ungating additional product features.
3. Increasing Customer Retention
Reducing churn and increasing customer retention are essential for driving LTV growth. That's because LTV is calculated by multiplying customer value by average customer lifespan. So, if you increase customer lifespan through improved retention rates, you'll increase LTV.
If you focus exclusively on customer acquisition and market penetration, you'll eventually hit a saturation point. That's why an LTV-based strategy is important for sustaining revenue and profit growth. With our project experience, we know that SaaS companies that increase LTV grow their installed base bookings by more than 20% each year.
So, what's their secret?
These companies understand how the three cornerstones connect, and they use price models, segmentation, and packaging to drive LTV. They've learned what works best for each of these levers, and what doesn't. To let you in on their secrets, here are some tips to consider when adopting an LTV growth strategy.
Best Practices for Growing Customer Lifetime Value
1. Make sure a subscription model is right for your business.
A square peg won't fit into a round hole and subscription models have been crowned the "Holy Grail" of recurring revenue. However, they can be extremely unprofitable when applied to the wrong industry, particularly the consumer industry where subscribers often cancel within the first few months and those who stay typically reduce spending over time. As a result, many companies fail to recoup acquisition costs, which are often high due to costly promotional offers and marketing campaigns.
If your company is having trouble determining the right pricing model for your product, you should consider the following questions outlined in the graphic below.
Source: Simon-Kucher & Partners
2. Select a pricing model that aligns with your customers' product usage.
As we mentioned above, not every pricing model is "one-size-fits-all." For example, think about the risks a subscription model has in an industry like ride-sharing. With a ride-sharing subscription, riders who frequently use the service are more likely to sign up than new users. Rather than acquiring more customers, it'll only attract users who are already customer advocates and don't need any extra incentive to use your product.
In these industries, customer loyalty programs can be much more effective than subscription models. The best loyalty programs combine hard benefits, like rewards, with softer, relationship-driven ones. For instance, a soft benefit could be inviting members to join a beta testing group and submit ideas to your team. What's key is that your loyalty program isn't a mere discounting scheme but rather a means to building a mutually beneficial relationship.
3. Choose a range of metrics to measure success.
Even if your aim is to go with a very simple pricing model, it should not impede LTV growth as you move forward. One common pitfall is to rely on a price metric that doesn't scale or plateaus over time. While the tech world often defaults to a user-based metric, relying solely on this can limit your ability to capture higher prices in the future. So, be sure to consider a range of metrics to accurately measure success and ensure your pricing model is encouraging LTV growth.
4. Adopt a strategy that's dependent on customer success.
Whether you're charging per user or gigabyte, it needs to be in line with the value that you deliver. Understand where your organic growth will come from and ensure your pricing strategy sets up your customers for success.
One example is to create an "emerging company" offer where new customers can experience your product at an accessible price for the first 10 seats. As their team grows and becomes more dependent on your services, you can migrate them toward the standard price. And, it will present opportunities to upsell and cross-sell as you demonstrate your company's value over time.
5. Space out value for customers over time.
Another common mistake is trying to sell a premium product to a basic-level user. If you sell new customers a complex solution that's not easily onboarded, adoption will be low and customers will fail to recognize the value of your product.
Selling sequentially over time lets you grow with your customers. And, it's much more lucrative because you can sell users on premium products and upgrades. As you build trust through customer success users will become more dependent on your products and will rely on your business to achieve their goals.
6. Create cross-selling and upselling opportunities.
For more cross-selling opportunities, look at natural product combinations that customers are already buying. Quite often, you won't need to provide incentives but rather make customers aware of product availability and synergies.
To increase upselling, you need to understand product usage. For example, imagine if more than 50% of your customer base wasn't using a specific feature, but the top two percent was heavily engaging with it. The bulk of your customers would benefit from its removal, but you don't want to deprive your most loyal users. This leaves you with two options.
First, you can monetize it as part of your basic package, but then you'll be too expensive for the bottom 50% who don't value this feature. Unless your top two percent of customers can recoup those losses, it's probably not worth the investment.
Your next option is to create a packing lineup where users can purchase the feature as an add-on. This achieves the best of both worlds and creates a path to upselling customers. By not giving away all of your product's features upfront you'll create opportunities to grow customer value over time.
7. Take a proactive approach to customer retention.
Often, when renewal comes around or when your customer calls to cancel, it's too late to save them. Therefore, it's important to develop a churn model that flags customers with high a propensity to churn. This will alert your service team so you can deploy retention efforts ahead of time.
Additionally, you should understand which retention offers are most effective for your target audience and weigh the value of retaining a customer against the cost of saving them. Remember, saving a customer is not always about reducing prices but rather enhancing their experience with the product.
8. Develop a differentiated annual price increase strategy.
With a predictive churn model, you can introduce a price increase that returns value without risking additional churn. If you're aiming for a 5-7% price increase, the trick isn't to roll out a blanket spike. Instead, segment customers by their likelihood to churn and you'll know when you can increase price by 10% and when it should be 0%.
Following these guidelines will improve your pricing model and grow customer lifetime value. Putting the focus on increasing LTV when updating your price model, segmentation efforts, and packaging strategy secures your company sustained revenue and growth.
Before you begin, learn how to calculate customer lifetime value.