Customer tiering is an important strategy for managing accounts, allocating resources, and maximizing revenue in the world of B2B SaaS and subscription-based businesses. Many businesses used to group their customers by Annual Recurring Revenue (ARR), which is the amount of money a customer pays in subscription fees each year. ARR gives a quick look at how much money a customer is bringing in, but it doesn't show the full economic potential of a customer relationship.
When dividing up customers, businesses should focus on Customer Lifetime Value (CLV) instead. CLV is a more flexible and future-oriented way to group customers, which leads to better decision-making, keeping customers, and making money in the long run.
The Shortcomings of ARR-Based Customer Tiering
It may seem logical to use ARR as the main basis for tiering because customers with higher ARR bring in more money right now. But this method has a few problems:
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Ignores Long-Term Revenue Potential
ARR is a fixed measure that only looks at current revenue and doesn't take into account how much a customer will pay over time. A customer with a high ARR today might leave quickly, but a customer with a lower ARR might stay for years and even add to their contract. -
Overvalues Large, Short-Term Deals
Some customers sign contracts worth a lot of money, but they are likely to downgrade or leave. Putting them ahead of smaller but long-term, loyal customers can lead to resources being used in the wrong way. -
Fails to Account for Expansion Potential
A lot of customers start with small contracts and then get bigger over time. Tiering based on ARR doesn't take these customers into account, which means missed chances to make more money. -
Encourages Short-Term Thinking
If you only look at ARR, it can make sales and customer success teams want to close big deals, even if they are risky or won't last, instead of building long-term relationships. -
Does Not Consider Profitability
When you use ARR-based tiering, you don't take into account how much it costs to serve each customer. Some customers with high ARR need a lot of help, custom integrations, or frequent escalations, which makes them less profitable than customers with low ARR who are self-sufficient and low-touch.
Why CLV-Based Customer Tiering is Superior
Customer Lifetime Value (CLV) is a way to figure out how much money a business can expect to make from a customer over the course of their relationship. A CLV-based approach gives a fuller picture of customer value by including:
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Retention Rates: Customers who stay with you longer bring in more money, even if their ARR is lower at first.
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Expansion Potential: Some customers can spend more by buying more items or services from you.
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Profitability: CLV takes into account the costs of acquiring and servicing customers, making sure that the focus is on the most profitable groups.
Here’s why CLV-based tiering makes more sense:
01. Prioritizes High-Retention, High-Growth Customers
CLV-based tiering helps businesses focus on customers who will bring in the most money over time instead of just short-term sales.
02. Optimizes Resource Allocation
Customer success teams can spend less time on accounts with high ARR but a high risk of churn and more time on building relationships with long-term customers.
03. Aligns with a Value-Based Growth Strategy
Businesses can make plans that improve customer retention, boost revenue from expansion, and drive long-term growth by focusing on CLV.
04. Improves Forecasting and Planning
Because CLV looks at future revenue potential, it helps businesses make better predictions and strategic choices.
05. Encourages Proactive Customer Success Management
When customer success teams use CLV as their main metric, they can build long-term relationships instead of just reacting to problems. When a high-ARR customer is at risk of leaving, teams can do more than just try to limit the damage. They can actively interact with high-CLV customers through personalized experiences to make sure they keep growing and succeeding.
Implementing CLV-Based Customer Tiering
To move from tiering based on ARR to tiering based on CLV, businesses should:
01. Analyze Historical Data
Look at how often customers come back, how likely they are to buy more, and how much money you make over time. Historical data can help you figure out what makes high-CLV customers different and improve your segmentation criteria.
02. Segment Customers Based on CLV
Instead of just looking at current ARR, group customers into tiers based on their expected lifetime value. To make a better segmentation model, think about things like the length of the contract, the chance of expansion, and the risk of churn.
03. Adjust Customer Success Strategies
Give resources to customers who have the most potential to bring in money over time, not just those who have the biggest contracts right now. Putting the right customers first makes sure that the customer success team spends time where it will get the best return on investment.
04. Incentivize Long-Term Thinking
Instead of focusing on short-term ARR goals, make sure your sales and customer success teams are working toward CLV goals. Instead of just looking at the size of the first deal, performance incentives should reward long-term growth strategies like retention, customer advocacy, and expansion revenue.
05. Leverage Predictive Analytics and AI
Use AI-powered analytics and data-driven models to get a better idea of CLV. Machine learning algorithms can help find patterns in how customers act, figure out how likely they are to leave, and suggest ways to get high-CLV customers to interact with you more. Companies that use predictive insights can change their tiering models on the fly to stay ahead of what customers want.
Conclusion
ARR is a good way to get a quick look at how much money customers are making, but it doesn't tell the whole story about how valuable they are. Businesses that use CLV-based tiering make sure that they focus on customers who will help them grow their revenue in the long term, not just in the short term. Companies can better use their resources, keep more customers, and make the most money in the long run by using a CLV-driven approach.
Businesses can protect their growth plans for the future and build stronger, more valuable relationships with customers by using AI-driven analytics, smarter segmentation, and a change in how they think.
Image by Werner Weisser from Pixabay