Software Growth

LTV (Customer lifetime value)

Customer lifetime value estimates the gross profit a customer will generate before canceling. It compares segments well but is unreliable for young SaaS.

Customer lifetime value (LTV, also CLV or CLTV) is an estimate of how much money a customer will bring in over the whole time they stay with you. Founders use it to decide how much they can afford to spend to win a customer. The idea is simple and the number is easy to get wrong, so treat it as a rough guide.

The simple formula

For a subscription product with steady churn, expected customer lifetime in months is 1 divided by monthly churn rate. Multiply by average revenue per account (ARPA).

If customers pay $50 a month on average and 4% cancel each month, the expected lifetime is 1 / 0.04 = 25 months and LTV is $50 / 0.04 = $1,250.

The gross-margin-adjusted formula

Revenue is not what you keep. Hosting, payment fees and support come out of it, so use gross margin. Jason Cohen writes the same thing in his critique of LTV as MRR times gross margin, divided by monthly cancellation rate.

With an 80% gross margin, the same customer is worth $50 x 0.8 / 0.04 = $1,000 of gross profit. This is the figure to compare against your customer acquisition cost. The usual comparison, the LTV to CAC ratio, is commonly read against a rule of 3 or more. Skok's SaaS Metrics 2.0 also recommends a ratio above 3.

Why LTV is unreliable for young SaaS

  • It extrapolates. At 4% churn the formula implies a 25-month lifetime. If your product is 8 months old, you have never observed a customer that long. You are predicting two years beyond your data.
  • Churn is not constant. New customers leave faster than long-term ones, so early churn overstates the loss of surviving customers and understates the loss of new ones. A small sample makes the rate jump from month to month.
  • Every input moves. Cohen argues that MRR, margin and cancellations all change over time and that the single number can swing by 2x in a year. He cites HubSpot's LTV tripling within 18 months.
  • It hides what happened. A falling LTV can mean worse customers or a better price. The single figure cannot tell you which.
  • It ignores expansion and discounting. Money received in three years is worth less than money today, and growing accounts are worth more than the formula says.

What to track as well

Cohen recommends watching the parts separately: MRR, cancellations, gross margin and CAC. Add CAC payback period, which needs no lifetime guess. Spending $300 to win a customer who pays $50 a month at 80% margin pays back in 300 / 40 = 7.5 months. That is a number you can check against your own data now.

For small SaaS

Use LTV to compare, not to forecast. Calculate it for each plan or acquisition channel using the same method, and favor the group with the higher figure. Cap the lifetime at 36 months or so, and recalculate when you have a year of cohort data. Do not raise money or ad budgets on a headline LTV of $5,000 built on three months of churn.

Sources

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