The formula, part by part
LTV = ARPA × gross margin ÷ churn. ARPA is average revenue per account per month: MRR divided by the number of paying customers. Gross margin is the share of revenue left after the cost of serving customers, such as hosting, payment fees and support. Churn is the monthly customer churn rate, written as a decimal.
Dividing by churn is the same as multiplying by the average customer lifetime in months, because an average customer stays about 1 ÷ churn months. Some teams leave out gross margin and calculate a revenue LTV. That gives a bigger number, but it is not the profit you can spend on winning customers.
Why it is easy to overestimate
Young products have little history, and churn in the first few months is often higher or lower than it will settle at. A churn rate of 1 percent gives an average lifetime of 100 months, more than eight years, which few startups have seen. Cap the lifetime you assume, often at three to five years, and recalculate every quarter as real data comes in.
Calculate LTV for each segment as well as overall. A plan or customer type with low churn and high ARPA can have five times the LTV of another, and that tells you who to aim your marketing at.
Using LTV
LTV sets how much you can afford to spend to win a customer. Compare it with customer acquisition cost: an LTV to CAC ratio around 3 to 1 is the common rule of thumb for a healthy business. Raising LTV usually means reducing churn, raising prices or adding upgrades that existing customers want.
Example
A product has $10,000 MRR from 200 customers, so ARPA is $50. Gross margin is 80 percent and monthly churn is 4 percent. LTV is $50 × 0.8 ÷ 0.04 = $1,000, from an average lifetime of 25 months. If it costs $300 to win a customer, the LTV to CAC ratio is $1,000 ÷ $300, about 3.3 to 1.
Questions people ask
- What is a good LTV to CAC ratio?
- About 3 to 1 is the usual target. Much lower and acquisition is too expensive. Much higher can mean you are spending too little on growth.
- Is LTV the same as CLV?
- Yes. LTV, CLV and CLTV are all names for customer lifetime value.
Related terms
- Customer acquisition cost (CAC)Customer acquisition cost (CAC) is the average amount a business spends to win one new paying customer: total sales and marketing spend in a period divided by the new customers won in that period.
- Churn rateChurn rate is the share of customers, or of recurring revenue, that a business loses in a period. Monthly customer churn is the customers who cancelled during the month divided by the customers at the start of it.
- Monthly recurring revenue (MRR)Monthly recurring revenue (MRR) is the subscription revenue a business can expect every month, with annual plans counted as one twelfth per month. Annual recurring revenue (ARR) is the same number for a year: MRR × 12.
- Ideal customer profile (ICP)An ideal customer profile (ICP) is a description of the type of customer who gets the most value from your product and is most valuable to you: who they are, the problem they have, and how you can find them.
- Lifetime dealA lifetime deal is a one-time payment that gives a customer ongoing access to a software product, sold at a discount, often through marketplaces such as AppSumo, to bring in early paying users.