LTV — Customer Lifetime Value
What is LTV?
LTV (Lifetime Value), also called CLV or CLTV, is the value a customer brings to a business over the whole relationship; for decisions about acquisition budgets it is calculated on gross margin, not on revenue. The reason is simple: the cost of acquiring a customer (CAC) is paid back out of margin, not out of revenue that first has to cover delivering the service. LTV is always an estimate of the future. It says what a customer is likely to bring in, not what they already have.
How to calculate LTV for a subscription business
The simplest subscription formula is:
LTV = ARPA × gross margin ÷ monthly churn
Put another way, it is the monthly margin per account multiplied by the average customer lifetime, and that lifetime equals 1 ÷ churn. ARPA, the average monthly revenue per account, comes from MRR: it is MRR divided by the number of active accounts.
A worked example
The figures are illustrative. An ARPA of $250 and an 80% gross margin come from the MRR entry. Monthly churn is 2.5%, which is what that entry's five cancellations out of two hundred accounts give: 5 ÷ 200 = 2.5%.
- Monthly margin per account = 250 × 0.8 = $200
- Average customer lifetime = 1 ÷ 0.025 = 40 months
- LTV = 200 ÷ 0.025 = $8,000
Calculated on revenue, LTV would be 250 ÷ 0.025 = $10,000. That overstates the customer's value by 10,000 − 8,000 = $2,000, because it ignores the cost of delivering the service, and it is margin, not revenue, that has to pay back CAC.
Which churn rate to use
The MRR entry distinguishes logo churn, the share of customers who leave, from revenue churn, the share of revenue lost. The example above uses logo churn for simplicity, which assumes customers on similar plans. When customers differ in size, revenue churn is the better fit, because the two measures can drift far apart.
Revenue churn can be gross (cancellations and downgrades only) or net (after expansion from the remaining customers). With the NRR of 97% and GRR of 94% from the MRR example, net revenue churn is 100% − 97% = 3% and gross revenue churn is 100% − 94% = 6%. When NRR is above 100%, net churn is negative and the formula has no finite value. In that case, use gross revenue churn or cap the time horizon.
The formula also assumes a constant churn rate, which often does not hold: customers tend to cancel more often in their first months than later. In the month of the MRR example, cancellations took $2,300 out of $50,000, or 2,300 ÷ 50,000 = 4.6% of revenue. Plugging that single figure in would give 200 ÷ 0.046 ≈ $4,348, little more than half the value above. That is why churn is averaged over a longer period or measured by customer cohort.
Sensitivity to churn
If churn rises from 2.5% to 5% a month and the margin stays the same:
- LTV = 200 ÷ 0.05 = $4,000
- Average lifetime = 1 ÷ 0.05 = 20 months
- LTV:CAC = 4,000 ÷ 2,000 = 2, or 2:1
CAC payback is still 10 months, because it does not depend on churn. What changes is the share of the customer's lifetime it takes up: 10 ÷ 40 = 25% at 2.5% churn, but 10 ÷ 20 = 50% at 5%. Payback and LTV have to be watched together; payback can look exactly the same while LTV falls by half.
LTV:CAC
With the $2,000 CAC from the CAC entry, LTV:CAC is 8,000 ÷ 2,000 = 4, or 4:1, and payback is 10 months. A ratio below 1 means the business loses money on every customer it acquires. When reading higher values, keep the asymmetry in mind: CAC is cash spent today, while LTV is an estimate of future margin that depends on the churn assumption. A very high ratio is not always good news either; it can also mean the company is underinvesting in acquisition and growing more slowly than it could.
In "SaaS Metrics 2.0", David Skok writes that the best SaaS businesses have an LTV to CAC ratio higher than 3, and notes that many healthy SaaS businesses do not meet his guidelines in their early days. It is an observation about the best SaaS companies, not a norm for every business model.
LTV beyond SaaS
In a repeat-purchase business such as an online store, the formula looks different: average order value × orders per year × years as a customer × margin. The figures are illustrative: with an average order of $150, three orders a year for two years and a 30% margin:
- LTV = 150 × 3 × 2 × 0.3 = $270
Here LTV grows mainly through more frequent repeat purchases, which is where email marketing and remarketing come in. We write about winning store customers from search on our SEO for ecommerce page.
Historical vs. predictive LTV
Historical LTV is the margin a customer cohort has actually delivered so far; predictive LTV is an estimate from a formula or a statistical model. The first is certain but incomplete for young cohorts. The second is complete but only as good as its assumptions.
It is worth calculating LTV separately for each acquisition channel, because customers from different sources may churn at different rates. That has to be checked in the data rather than assumed. Assigning a customer to a channel depends on the attribution model. Our article on web analytics covers which data to track, and our SEO for SaaS page covers measuring the organic channel in subscription businesses.
Common mistakes
- Setting revenue-based LTV against CAC instead of margin-based LTV.
- Taking churn from a single month.
- Using one LTV for every segment, even though small and large customers may churn at different rates.
- Ignoring expansion, or counting it twice: once in net churn and again as separately added expansion revenue.
- A lifetime of many years derived from the very low churn of a young customer base: at 0.5% a month the formula gives 1 ÷ 0.005 = 200 months, more than 16 years.
- Treating LTV as money already in the bank.
Related terms
- MRR — the source of ARPA and of the logo vs. revenue churn distinction
- CAC — acquisition cost, set against LTV in the LTV:CAC ratio
- Churn rate — the cancellation rate LTV depends on most
- KPI — LTV and LTV:CAC as health indicators of a subscription business
- ROI — return on investment, measurable over the whole customer relationship
- SaaS SEO — search optimization for subscription software