Customer Lifetime Value (LTV) is a metric that estimates the value of one customer over their full life of being a customer.
LTV is also commonly referred to as CLV or CLTV. They all reference customer lifetime value.
LTV can be difficult to conceptualize and hard to compute (particularly if you have limited historical data). But that’s what this article is here to help you with today.
I will breakdown the components of the LTV formula and answer the following questions for you:
Customer Lifetime Value is important to understand so that you can make strategic decisions and allocate resources effectively.
LTV is particularly important when considering how much you can spend to acquire a new customer, see LTV:CAC Ratio.
In subscription software businesses (SaaS), customers often pay smaller monthly amounts, but over a longer period of time. So while the customer has not paid you very much upfront, the amount they pay you overtime as a customer becomes meaningful.
For example, if your average monthly churn is 1%, your average customer sticks around for 100 months or 8.3 years (1 / .01). Now imagine that customer pays you $25/mo. 100 months x $25/mo = $2,500 in revenue. That’s much more interesting.
Before you start crunching numbers, think about how you want to use the LTV formula. Are you looking to analyze your entire customer base? Do you want to look at specific cohorts? Are you interested in customers by industry?
Start with the question you’re looking to answer and how you want to use the calculation before jumping into the numbers.
Now that you’re ready, calculate customer lifetime value using these 4 elements:
The customer lifetime value (LTV) formula is used in the LTV calculation example below.
Average Revenue Per User (ARPU) x % Gross Margin / Churn Rate = LTV
Let’s break those components down. Let’s say your ARPU is $25/mo. That’s $25 of monthly recurring revenue (MRR). Then let’s say it costs you 5-20% to service that customer (cost of goods sold, think hosting costs, credit card fees, support cost). Let’s assume 10%. So your Gross Margin equals 100% - 10% COGS = 90% gross margin. Then lastly, let’s assume your monthly churn rate is 5%. Here’s your LTV calculation:
$25 MRR x 90% / 5% = $450 LTV
That’s a customer lifetime value of $450. Now, a general rule of thumb is that you want to achieve at least a 3X LTV:CAC ratio. So this would mean, you should not spend more than $450 / 3 = $150 to acquire that customer.
There are 3 ways to increase your customer lifetime value. Look at the numerators in the equation.
That’s really it.
Take a close look at the Ideal Customer Profile (ICP) Template. At our venture-backed, B2B SaaS company, before we calculated LTV, we did a deep dive into who our ideal customers really are. This helped us be able to run an LTV analysis looking at the highest value customers across different customer attributes.