Customer lifetime value for subscription models

The subscription revenue model is becoming increasingly popular across a range of different business sectors. Where the subscription model was once mainly confined to newspapers and magazines, it is now offered for products and services as diverse as gym membership, printer ink, streaming platforms and software as a service. With the opportunities offered by the subscription model come a range of challenges if a business is going to take full advantage. One of those challenges involves making it as simple as possible for your customers to make regular subscription payments. The good news is that partnering with GoCardless simplifies the subscription revenue model payment process, with 97.3% of automated recurring payments collected on the first try.  Regular subscription payments help to maintain the cash flow into your business, but cash flow alone is not enough to understand how successful the subscription model is for your business. To do this, you need to be able to calculate how much revenue each customer is likely to bring into your business during the length of their subscription, and that means calculating the customer lifetime value for your subscription model. 

What is customer lifetime value?

Whereas the transaction revenue model makes it easy to calculate the profit margin generated by a customer on a sale by sale basis, the subscription model makes this slightly more complex. In order to work out exactly how profitable a particular product or service offering is over a longer period of time, it helps to be able to know how much profit each customer generates during their customer lifetime. One of the key advantages of the subscription model of revenue is that it helps to promote customer retention, rather than driving growth through on-going customer churn, but this means that it is vitally important to calculate the total profit each customer is likely to generate during the course of their lifetime as a customer. This is the customer lifetime value, and with this figure it becomes possible to decide exactly how much it is worth investing in acquiring each new customer. This knowledge – the return generated on the acquisition of a new customer – makes it easier to decide exactly how much to spend on drivers of customer acquisition such as sales, marketing and product development. 

How to calculate customer lifetime value

There are various methods that can be used to calculate customer lifetime value for a subscription model. The precise model used will vary from business to business, as the person calculating the customer lifetime value will need to decide which aspects of the business need to be considered in terms of expense in relation to each customer. In simpler terms, the metrics needed to calculate customer lifetime value include the following:

• The average value of each order 

• The rates of customer retention and repurchase

• How much it costs to acquire and retain each customer 

For a subscription model start-up the retention rate will be based on an assumption, whereas, for a subscription model which has been up and running for some time it should be possible to come up with a firm and provable figure. The number of customers with a subscription needs to be compared on a year by year basis and if, for example, 80 out of every 100 customers from the precious year are still customers in the following year, then the customer retention rate is 80%. The retention rate needs to be calculated on a year by year basis to give a realistic view of the success of the business in retaining customers, because a 12 month subscription tends to be the default model, so a rolling or month by month retention rate would give an unrealistic result.   

The cost of acquiring each customer can be calculated by taking the overall cost of all measures taken to acquire customers – such as marketing and sales – and dividing that amount by the number of new customers acquired over a 12 month period. The subscription model imposes a repurchase rate of 12 items per year, i.e. 12 monthly subscription payments, and the contribution margin is simply the amount of each monthly subscription payment.  It is therefore possible to calculate customer lifetime value for a particular subscription business using the following figures:

• Customer acquisition costs = £80

• Customer retention rate = 80%

• Repurchase rate = 12 per year

• The contribution margin = £25 

With these figures in place, the customer lifetime value calculation would be set out as follows:

The average customer lifetime is calculated in the following way:

1/ (1- 0.80) = 5.01 years

With the customer lifetime in place it is possible to make a calculation of customer lifetime value based on the contribution margin multiplied by the number of purchases, with the result then multiplied by the customer lifetime. The result of this calculation is then reduced by subtracting the acquisition costs, to arrive at a final figure:

(£25 x 12) x 5.01 years - £80 customer acquisition costs = £1,423

Using this calculation, it is possible to place a value of £1423 on each new customer across the average customer lifetime, although the true figure might be complicated by issues such as premium of bargain subscription rates and sales which are additional to the basic subscription. Even the basic calculation of customer lifetime value for a subscription model is still useful as a predictive tool, however, making it simpler to plan future spending with a degree of certainty.  It also places an emphasis on the retention of customers, since the longer the lifetime of each customer is, the more value they will bring into the business. 

How to increase customer lifetime value

There are steps which a business can take to increase customer lifetime value:

• Focus on customer satisfaction – whatever it is that your business provides, from regular goods to access to software, you need to make it as easy as possible for each customer to get hold of exactly what they need. 

• Make things easy – making payments should be as easy as possible for your customers, removing the kind of friction which is likely to prompt them to opt to cancel their subscription. Automated monthly payments through GoCardless, for example, take the responsibility for making payments out of the customer’s hands and, from the point of view of the subscription business, guarantee a regular income stream. 

We can help

GoCardless is a global payments solution that helps you automate payment collection, cutting down on the amount of financial admin your team needs to deal with. Find out how GoCardless can help you with one-off or recurring payments.