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Maximizing CLV: Understanding the Key Drivers and Their Relationship
The first step to knowing how to improve CLV
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Let’s dive in.
Understanding the drivers of CLV — and their relationship to each other — is essential to understanding how to improve CLV. In our last post, we briefly covered customer lifetime, one of the most influential drivers of CLV. We'll join customer lifetime with contribution margin, unpacking it into three key drivers: 1) revenue, 2) variable costs, and 3) marketing costs.
The four primary drivers of CLV:
Customer lifetime — how long someone will remain a paying subscriber before they cancel (if ever).
Revenue — average revenue per user ("ARPU"), expressed on a monthly basis (monthly recurring revenue, "MRR") or annual basis (annual recurring revenue, "ARR"). ARPU usually ties closely with your subscription price but can fluctuate based on discounts, special offers, and price increases.
Marketing costs — the cost to acquire customers ("CAC").
Variable costs — costs that scale or have a close relationship with revenue growth.
The challenge with improving CLV is these drivers are all interdependent — a change in one of the drivers usually impacts at least one of the other drivers. It's challenging, if even possible, to improve all these drivers simultaneously.
Over the years, we experienced a few common scenarios where this tug-of-war would play out. Let's start by imagining a world where all the variables are in perfect harmony and CLV is at its optimal point.
But over time, you start to think your product is underpriced and decide to increase the subscription price. Increasing your price will immediately impact ARPU, especially if you adjust the price for existing subscribers. As such, price increases can be one of the quickest ways to boost CLV.
But, all else equal, we're selling the same product at a higher price. Attracting new subs will become more challenging, leading to a higher CAC. If pressed too far, a price increase can also erode retention for existing subscribers and shorten customer lifetimes. For a price increase to have a net-positive impact on CLV, the increase in ARPU must outweigh the rise in CAC and erosion of customer lifetime.
Another common scenario: we want to spend more on marketing to accelerate subscriber growth. Let's say we're approaching the last few months of the year and things have been going well. Our investors come to us and ask what would happen if we doubled the marketing budget for the rest of the year. (There was usually an ambitious end-of-year subscriber target floating in the air.)
Ramping up marketing spend can amplify growth, but it can also lead to inefficient spending and lower-CLV subs. As we spend more on marketing, our targeting usually shifts from core to peripheral audiences, leading to more expensive bidding, fewer leads, and lower conversions. Our CAC goes up.
At the same time, we're acquiring subs with less interest in our product. A higher share of subscribers will likely cancel immediately, reducing customer lifetimes.
A significant increase in marketing can be a good investment and help bring in many more paying subscribers. But it almost always reduces CLV, often to a point where the CLV to CAC ratio no longer makes sense. For it to be a sound investment, we must weigh how much we accelerate growth against how much CAC goes up and how much we shorten customer lifetime.
There are endless scenarios, but here’s the key point: improving CLV is a delicate dance of inching all the drivers in the right direction. If we focus too much on one driver, we'll likely harm the other drivers, which could lead to a net-negative impact on CLV.
Now that we're on solid ground, our next posts will dive into building a CLV model and discussing a few influential components.
In the meantime, let me know what you think in the comments or by replying to the email.
Thanks for reading,
A price adjustment (up or down) can lower CLV and drive more revenue depending on how it impacts total paid subscribers. For example, if you lower your price, there's a good chance it will also reduce your CLV. But it may also expand your addressable audience and drive an influx of new paying subscribers, ultimately increasing your overall revenue.