Today I have for you the last post in my ROI measurement series. This post walks you through how to measure the ROI of personalization when used to improve customer success by subscription-based businesses such as software-as-a-service (SaaS). If this doesn’t apply to you but you are looking to evaluate investments in personalization for other benefits, I’ve previously written about measuring the ROI of personalization for improving demand generation, content publishing and e-commerce.
The following ROI calculations assume that your business derives revenue from renewing current customers, upselling/cross-selling current customers, and/or converting free trials or freemium users to paid customers. We have seen personalization impact each of these areas, so there are several calculations below. But it’s manageable if you break it into sections as I do below.
The formula for calculating basic ROI is simple — you just need to isolate the gain you receive and divide it by how much you spend to achieve that gain.
% ROI = (Gain/Investment) x 100
Before you begin, you’ll need several variables. Since not every company will necessarily have all three of these revenue sources, I’ve split out the variables according the calculation in which they are used to help you identify which ones you need depending on your business model.
All calculations will need:
- Total number of customers
- Average annual contract value (ACV)
- Average number of years per customer (optional)
- Gross margin
- The cost of a personalization solution
- Average annual renewal rate
- Number of freemium users or free trialers per month
- Monthly free-to-paid conversion rate
- Monthly upsell/cross-sell conversion rate
- Average upsell/cross-sell transaction as a percent of ACV
How to calculate customer lifetime value
To ensure that each of these three calculations calculate the impact of your personalization efforts on the same variable, we need to start by calculating your average customer lifetime value (LTV). Incremental LTV gained per month is how we’ll ultimately measure the gain from personalization.
Average customer LTV is calculated by multiplying your average contract value by the average number of years you retain your customers (i.e. customer lifetime) by the average gross margin per customer contract. So if you have an annual contract value of $6,000, you retain customers for an average of 4.0 years, and your gross margin is 83.33%, you would have an LTV of $20,000.
Average Customer Lifetime Value (LTV) = Avg Annual Contract Value x Avg Number of Years per Customer x Gross Margin
$6,000 x 4 years x 83.33% = $20,000
Note: If you do not have or are unsure of your average customer lifetime, you can compute this by dividing 1 by your annual churn rate (churn rate = 1 - renewal rate).
Next, because we ultimately want to identify incremental LTV gained per month, you need your average monthly LTV per customer. This is calculated by simply dividing your average LTV by the average number of years per customer multiplied by 12. So in this example, your average monthly LTV is $417.
Average Monthly LTV per Customer = Average LTV/(Avg Number of Years per Customer x 12)
$20,000/(4 x 12) = $417
Note: If you want to dig deeper into the topic of LTV and other key SaaS metrics, be sure to check out VC investor David Skok’s forentrepreneurs blog. And for a variety of useful resources for around managing customer lifetime value, I’d recommend checking out customerssuccessassociation.com.
How to calculate impact on retention
Now we need to calculate the incremental LTV gained from personalization on each of the three revenue drivers, starting with retention.
We begin by calculating the impact on the number of customers you retain through personalization. The number of customers you retain can be calculated by multiplying your total number of customers by your annual retention rate. So before personalization, if you have 2,000 customers and a retention rate of 80%, you have 1,600 customers at the end of year (not including any new ones you gained throughout the year).
Number of Customers Retained = Total Number of Customers x Annual Renewal Rate
2,000 x 80% = 1,600 customers
Now, if we assume that personalization improved your renewal rate by 1%, you would have a new renewal rate of 80.8%. This would result in 1,616 customers retained.
2,000 x 80.8% = 1,616 customers
Now let’s calculate the impact on LTV from an increase in the renewal rate. This is found by simply multiplying the difference in the number of customers retained by the average monthly LTV we calculated above. In this example, the incremental monthly LTV gained is $6,672.
Incremental Monthly LTV from increased retention rate = (New Number of Customers Retained - Old Number of Customers Retained) x Average Monthly LTV per Customer
(1,616 - 1,600) x $417 = $6,672
How to calculate impact on free-to-paid
Next, we’ll do a very similar calculation to the one above, but this time for a free-to-paid customer conversion. This applies in situations where free trialers or free users of your product or service convert to paying customers.
We begin by calculating the increase in the number of customers you expect to gain through personalization. The number of customers you gain is calculated by multiplying your total number of free trials (or freemium users) each month by your monthly conversion rate. Before personalization, if you have 1,000 free users and a conversion rate of 3%, you have 30 new customers each month.
Number of Customers = Total Number of New Free Trials or Freemium Users per month x Monthly conversion rate
1,000 x 3% = 30 new customers
If personalization improved your conversion rate by 16%, you would have a new conversion rate of 3.5%, resulting in 35 new customers.
1,000 x 3.5% = 35 new customers
Finally, we need to calculate the impact on LTV from this increased free-to-paid conversion rate. You can calculate that by multiplying the difference in the number of customers gained by the average monthly LTV. In this example, the incremental monthly LTV gained is $2,085.
Incremental Monthly LTV from increased free-to-paid conversion rate = (New Number of Customers - Old Number of Customers) x Average Monthly LTV per Customer
(35-30) x $417 = $2,085
How to calculate impact on upsells/cross-sells
After calculating the incremental LTV gained from improving retention and free-to-paid conversion rate, we finally need to calculate the impact from increasing upsells and cross-sells.
Just like in the two examples above, we begin by calculating the increase in the number of upsells/cross-sells you gain through personalization. The number of customers you upsell is calculated by multiplying your total number of customers by your annual upsell conversion rate. Before personalization, if you have 2,000 customers and an upsell conversion rate of 10%, you have 200 new upsold customers each year.
Number of New Upsells = Total Number of Customers x Annual Upsell Conversion Rate
2,000 x 10% = 200 customers
If personalization improved your upsell rate by 15%, you would have a new rate of 11.5%, resulting in 230 upsold customers per year.
2,000 x 11.5% = 230 customers
Unlike for the other two calculations, to calculate the impact on LTV from upsell/cross-sell improvements we first need to identify the average LTV of each upsell. This can be found by multiplying the average monthly LTV by the percentage of the contract value that upsells make up. So if that percentage is 20%, your average monthly LTV of an upsell is $83.40.
Average LTV of Upsell = Average Monthly LTV per Customer x Avg. Upsell Percent of Contract Value
$417 x 20% = $83.40
Finally, we need to calculate the incremental LTV from increasing the upsell/cross-sell rate. We just need to multiply the difference in the number of upsells by the average LTV of an upsell that we found above. In this example, the incremental LTV gained is $2,502.
Incremental LTV from increased upsell/cross-sell rate = (New Number of Customers - Old Number of Customers) x Average Monthly LTV of Upsell
(230-200) x $83.40 = $2,502
Putting it all together
To identify the total incremental LTV gained per month, we just need to add up the numbers we got in each of the previous three sections. In this example, your total incremental monthly LTV is $11,259. Of course, if one or more sections don’t apply in your situation or you want to isolate the benefits, just exclude the numbers for the section(s).
Incremental LTV per month = Incremental LTV per month from Retention + Free-to-Paid + Upsells/Cross-sells
$6,672 +$2,085 + $2,502 = $11,259
How to calculate ROI of personalization
At this point, you have identified what you gain from your personalization, in the form of incremental lifetime value per month. To calculate the ROI, we just need to divide this by your investment.
% ROI = (Gain/Investment) x 100
If you spend $30,000 per year on a personalization solution, that would be a monthly cost of $2,500 and a 450% ROI!
($11,259/$2,500) x 100 = 450%
How to calculate breakeven point
Nice job! We’re nearly finished. Let’s just take it one step further to figure out how many months it will take you to make back your investment, by dividing your yearly upfront cost by your incremental LTV per month. In this case, it’s just 2.7 months!
Breakeven point = Yearly cost/Incremental LTV per month
$30,000/$11,259= 2.7 months
The calculations in this article may seem a little complicated, because there are multiple ways personalization can impact customer success. Think about which areas are impacted (or will be impacted) by your personalization efforts, and then select the appropriate calculations.
Be sure to post comments below with any feedback or questions. Good luck!