Customer Lifetime Value (LTV or CLV)
The estimated value of revenue you’ll generate from your entire relationship with a customer.
It has other names as well. Customer lifetime value (CLV or often CLTV), lifetime customer value (LCV), or life-time value (LTV) all are the name for the prediction of the net profit attributed to the entire future relationship with a customer.
How much revenue are your customers generating?
Customer Lifetime Value (CLV or LTV) is an estimate of the average gross revenue a customer will generate before they churn.
How to calculate customer lifetime value
You can calculate LTV in a few different ways. You can look at it using the Average Revenue Per Account (ARPA) formula, or you can use a formula that incorporates MRR contraction and other churn.
The ARPA formula is as follows:
LTV = (ARPA x Gross Margin %) / Customer Churn Rate
Here, you need to know three variables: your average revenue per account, your gross margin, and your churn rate.
- ARPA is the average revenue per account. You can calculate this by finding the average MRR across all of your active customers.
- Gross margin is the difference between revenue and COGS (Cost Of Goods Sold). This is typically pretty high in SaaS (>80%).
- Your customer churn rate is the rate at which your customers are cancelling their subscriptions.
This formula is great for a starting point and is useful when building your metrics. However, it doesn’t really account for MRR, contraction, or non-linear churn.
The second formula may be more useful for SaaS or subscription-based companies.
LTV = (Price of a monthly subscription) / Customer Churn Rate
This more SaaS-specific formula gives you an idea for how much a customer can be expected to pay you over their lifetime with your company, as well as allowing you to see how long you should expect your customers to last.
Why does lifetime value matter?
You can balance your customer acquisition spend. If you know your lifetime value is X amount, you get a better idea for how much you can spend on customer acquisition without too much risk.
Get a gauge on which customers are more profitable. When you calculate your LTV to CAC ratio for different customer types, you can determine which industries or customer sets are more efficient to acquire. You could also discuss how to make the less profitable customer sets more profitable.
Many investors count LTV along with CAC as part of determining the health score of a company.
What to watch out for
Ratio of LTV to CAC. As a rule of thumb, the LTV to CAC ratio for SaaS companies should be about 3:1. This will also help you determine your payback period. You’ll want to aim to recover your CAC in around 12 months, and this comes from your customer lifetime value. If you go much longer than this, your business will require a lot more capital in order to grow.
Lifetime Value Example
Say your company’s average revenue per account (ARPA) in MRR is $100. Your gross margin is 80%, and your churn rate is 3%. This is what your calculation would look like:
(100 x .80) / 0.03 = $2666.67.
This means that one of your average customers, over their lifetime relationship with your company, will generate $2666.67 in revenue.
Monthly Subscription Calculation
Let’s say your company offers a product for a contract at $20 per month and you have a churn rate of 7%. Here’s what your calculation would look like:
20 / 0.07 = $285.71
This means that you have a lifetime value of almost $286. If you divide that value by the amount per your time frame, it gives you the amount of time that you expect this customer to stay before they churn. In our example, the contract is on a monthly basis.
285.71 / 20 = 14.29
This means that the expected lifetime for your customer is about 14 months.
How to influence lifetime value
Customer Retention. Keeping good customers is just as important as selling new ones. Most sources say it costs between 4 and 10 times less the amount of money to retain current customers than it does to recruit a new customer. Research also shows that increasing customer retention by just 5% can increase profits by as much as 85%.
Decreasing churn rate. Decreasing your churn rate even in small amounts can change the lifetime value and your prospective revenue in great measure. You may consider what things in your company are causing customers to churn.
Lifetime Value for eCommerce
- For eCommerce, calculating LTV is a little different, because you are often dealing with non-contractual relationships, making it a little tougher to predict purchase behavior.
- Hubspot presents this equation for eCommerce companies: LTV = (Average Order Value) x (Number of Repeat Sales) x (Average Retention Time). You may want to also check out Kissmetric’s article on calculating LTV.
Lifetime Value for Startups
- If you’re running a startup, calculating LTV is going to be tougher, given that you have limited or inconsistent data while trying to find a scalable growth model. David Skok suggests waiting to calculate LTV (and CAC along with it) until you have “a repeatable and scalable growth process.” That way, the numbers will be both reliable, meaningful, and actionable. He also presents some other ideas for estimating LTV and CAC before you’ve reached that model.
Lifetime Value for SaaS
- With subscription-based SaaS companies, you will likely be using the “monthly subscription” calculation above to determine your LTV.
- Baremetrics suggests that SaaS companies should know what the LTV is for each of your major customer segment. That often means the various price points you offer. You may also want to consider calculating the LTV for customers by their acquisition channel. This will give you a better idea for the types of customers coming in by channel, and which ones are more profitable.
Lifetime Value for Marketing Agencies
- Calculating lifetime value may be a little different for marketing agencies. Hubspot suggests two approaches---calculating LTV for retainer-based clients and calculating it for project-based clients.
- For retainer-based clients, you can calculate your minimum LTV based on the contract, expanding it by measuring past client behavior for other similar clients. For project based-clients, the principle is the same: calculate the LTV based on the contract for the project, and factor in other similar clients’ behavior.
Add a lifetime value metric tile to your dashboard!
Who drives lifetime value. VP of Customer Success. The VP of Sales is responsible for selling great customers that stay a long time, but usually the VP of Customer Success is responsible for tracking and improving LTV.
Lifetime value chart type(s).
- Pie Chart -- the proportion of total value each customer group represents, or the proportion of total customers that provide specific LTV levels.
- Column & Line -- Rolling average lifetime value of previous 12 months (column) and 12 months prior (line).
Measure. What we’re measuring.
Date range. 1 year
Display interval. 1 month
Key Value. Average LTV rolling year.
Comparison Value. Average LTV previous rolling year.
Data Source(s) for tracking lifetime value
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