Lifetime value
LYFE-time VAL-yoo
The total gross profit expected from a customer over the entire relationship. LTV determines how much you can spend to acquire them.
LTV estimates how much total revenue you will earn from a customer over the entire relationship. The simple version: take the average revenue per customer per year, divide by your annual churn rate. If customers pay you $20k per year and your churn is 10%, your LTV is $200k. The math: a 10% churn rate means the average customer stays for 10 years. Multiply by $20k and you get $200k.
One catch. CFOs do not think in revenue. They think in gross margin. Gross margin is what is left after you subtract the direct costs of delivering your product: hosting, support, infrastructure. If a customer pays you $100k but costs you $30k to serve, your gross margin is $70k, or 70%. Real LTV calculations use gross profit, not revenue.
A customer paying $100k at 70% margin is worth more than a customer paying $120k at 40% margin. The first one nets you $70k per year. The second nets you $48k. Margin determines value, not price. Most SaaS companies aim for gross margins above 70%.
Examples
A developer tools company with low churn.
Average revenue per customer is $24k/year. Annual churn is 8%. Average customer lifespan is 12.5 years. LTV = $24k x 12.5 = $300k. At 75% gross margin, gross-profit LTV is $225k.
A self-serve product with high churn.
Customers pay $1,200/year ($100/month). Monthly churn is 5%, which annualizes to roughly 46%. Average lifespan is about 20 months. LTV is only $2,000. You cannot spend much to acquire these customers.
Board presentation comparing two segments.
Enterprise customers: $150k ACV, 5% churn, LTV = $3M. SMB customers: $12k ACV, 20% churn, LTV = $60k. The enterprise segment is 50x more valuable per customer. That is why enterprise sales teams exist.
In practice
Read more on the blog
Related terms
The total cost of sales and marketing divided by the number of new customers acquired in a period.
Lifetime value divided by customer acquisition cost. The fundamental unit economics equation for any subscription business.
The rate at which customers cancel or do not renew. Measured as logo churn (customers lost) or revenue churn (dollars lost).
Revenue minus cost of goods sold, expressed as a percentage. For SaaS, this is revenue minus hosting, support, and delivery costs.
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