Customer lifetime value (LTV) and LTV to CAC

Customer lifetime value (LTV)

Customer lifetime value (LTV) estimates the gross profit a customer generates over the expected life of the relationship. In SaaS it is usually average revenue per account multiplied by gross margin and divided by a churn rate, either customer churn or gross revenue churn. Set against acquisition cost, it gives the LTV to CAC ratio.

Formula

LTV       = ARPA × gross margin % ÷ churn rate
            (ARPA and churn on the same monthly or annual basis)
LTV : CAC = LTV ÷ cost to acquire one customer

Worked example

Illustrative figures. Monthly ARPA and monthly gross MRR churn.

LTV = 4,000 × 80% ÷ 1.5% = 213,333

LTV : CAC = 213,333 ÷ 60,000 = 3.6

Sensitivity to churn

Because churn is the denominator, LTV is highly sensitive to it. At a monthly churn rate of 0.5%, the implied lifetime is 200 months, over 16 years, longer than most investors will credit. Cap the lifetime, for example at five years, or discount future gross profit.

Which churn rate

Gross revenue churn ignores expansion and is conservative. Net revenue churn includes it and can be negative, which makes the result meaningless. Use gross churn, or model expansion explicitly.

Cohort-based LTV

Where history allows, build LTV from cohorts: cumulative gross profit per customer by month since acquisition. Observed behaviour replaces an assumed churn rate.

What Revnewed provides

Revnewed calculates ARPA, logo churn and gross MRR churn every month, and cohort tables of revenue retention by month since acquisition.

Gross margin and acquisition cost come from the general ledger and are not held in Revnewed.

Common misstatements

Uncapped lifetimes: Low churn produces lifetimes no investor will accept.
Revenue in place of gross profit: LTV is a profit measure; revenue overstates it by the cost of service.
Net churn in the denominator: Negative net churn makes the formula meaningless.