Customer Lifetime Value (CLV) metrics are commonly used in software, SaaS and subscription-based businesses. Given the re-occurring nature of technology services companies, we can bring these concepts from SaaS, adapt them and apply them to tech services.
CLV data attempts to guide decision-making in software businesses. As companies start to understand their CLV, they can make marketing and sales decisions that are in sync with the value of customers they are supporting. For example, if an average customer is worth $800 of revenue during their lifetime with the business, the software company will look to acquire an average customer for less than this amount, of course. The marketing or growth group now has parameters on how much to spend to acquire customers. Once the company understands this data, they can start to refer to this cost as Customer Acquisition Cost (CAC). Assuming CAC is $200, then the CLV / CAC ratio in this case ends up being 4x.
Due to the high gross margin in software, it is common for CLV metrics to be calculated at the revenue level. This is not the case for technology services. We will describe the adaptation that we use below.
In technology services, cost of goods sold or cost of sales is typically labor (the cost to deliver the projects that generated the revenue). It is unusual to have 70%-80% gross margins. Gross margins are typically within 40%-60% in services, depending on several factors like geographic team location, niche expertise, type of engagement, etc.
If we are looking to assess how much value needs to flow from the upper levels of the income statement to the operating expense levels to pay for sales and marketing (to generate that revenue!), we need to adapt the CLV formula to take into consideration the cost of sales. This guides us to use gross profit figures rather than straight revenue numbers.
Using the same metrics as in the prior example, if that company had 50% gross margins, then the average CLV would be $400. With $200 in CAC, the CLV / CAC ratio ends up being 2x.
Tracking these metrics is relevant in technology services. We can also extend analyses to include cost per lead and cost per opportunity, building up to the CAC, while calculating conversion rates for each level of the funnel.
As you scale your technology services business, try to implement sales and marketing metrics that can help in making growth investment decisions.
Please reach out to us if you want to learn more. At Alten Capital we invest and help grow global technology services companies.