CLV Part II: Constant Tradeoffs
Core Drivers of CLV, Their Interdependence, and Search for Balance
Understanding the drivers of CLV, and their relationship to each other, is a key step towards understanding how to improve CLV. From the previous section, let's grab customer lifetime as a primary driver. We'll join it with contribution margin, unpacking it into 3 key drivers: 1) revenue, 2) variable costs, and 3) marketing costs.
4 primary drivers of CLV:
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Revenue ("ARPU") - average revenue per user, per month (or year, depending on subscription term). In its simplest form, this maps to the recurring subscription cost.
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Marketing cost ("CAC") - cost to acquire paying subscribers.
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Variable costs - costs that scale or have a close relationship with revenue growth
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Customer lifetime - the average point when a customer will cancel
The challenge with improving CLV is these drivers are all interdependent. It's difficult, if not impossible, to improve all these drivers at the same time. Let's explore a few common scenarios where this plays out.
To start, let's imagine a world where all the variables are in perfect harmony, and CLV is at its optimal point.
But perhaps over time, we start to believe our product is under-priced. We decide to increase subscription prices (i.e. ARPU). Increasing price is one of the swiftest 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 subs. Diminishing retention reduces our expectation on customer lifetimes. For a price increase to be net-positive and actually improve CLV, the increase in ARPU must outweigh the increase in CAC and erosion in customer lifetime.
Another common scenario: we want to elevate marketing spend to accelerate sub growth. More than a few times, investors would ask what would happen if we doubled marketing spend. There's often an audacious end-of-year sub target floating in the air.
In practice, while it can amplify growth, it usually leads to inefficient spend and lower-CLV subs. As marketing spend goes up, targeting usually shifts from core towards peripheral audiences. The shift away from our core audience leads to less efficient spend (more expensive bidding, lower conversions, etc.). CAC goes up.
At the same time, we're acquiring subs with less interest in our product. It's likely a higher share of subs will cancel right away, reducing customer lifetimes.
A big increase in marketing spend can be a good investment, helping boost growth rates. But it's almost surely going to reduce CLV. There's a breaking point where the CLV : CAC ratio no longer makes sense. For it to be a sound investment, we have to weigh how much we accelerate growth against how much CAC goes up and how much lifetimes shorten.
If there's one take away from the entire CLV section, let it be this! Improving CLV is a delicate dance of inching all the drivers in the right direction. Too much focus on one driver may deteriorate the other drivers, to a degree that may erode CLV.
Now that we're on solid ground, let's start to build a CLV model and discuss each key component.
