Lifetime Value (LTV)

Lifetime value (LTV) is the total gross profit a customer is expected to generate over the time they remain a customer. It's used alongside customer acquisition cost (CAC) to evaluate whether a business can profitably scale. The metric must be calculated on gross margin, not revenue, because only gross-margin dollars are available to repay CAC and fund the rest of the business.

The standard SaaS formula is LTV equals average revenue per account (ARPA) times gross margin percent, divided by monthly customer churn rate. A SaaS company with $200 monthly ARPA, 80 percent gross margin, and 2 percent monthly churn has an LTV of ($200 x 0.80) / 0.02 = $8,000. This formula assumes a steady-state churn rate and works reasonably well for businesses with mature retention curves. For early-stage companies with short histories, cohort-based LTV (tracking the actual retained revenue of a specific cohort over time) is more honest than the formula, because the formula extrapolates a churn rate that may not yet be stable. The other adjustments worth knowing: most credible LTV calculations cap the time horizon (3 to 5 years rather than infinity) and account for expansion revenue (account growth from existing customers) as well as churn. Paired with CAC, the LTV:CAC ratio of at least 3x is the widely cited benchmark for healthy unit economics.

Ryan's Take

Founders compute LTV on revenue, with a wishful churn rate, over an infinite horizon, and get a number that makes the deck look fantastic. Then investors recompute on gross margin with the actual churn rate and a 5-year cap, and the number drops by 60 percent. Build the honest version from the start. Use gross margin. Use cohort retention if you have enough history. Cap the horizon at 5 years. If the honest LTV doesn't beat your CAC by 3x, you don't have a marketing problem, you have a retention problem or a pricing problem. Fix the cause, not the spreadsheet.

What founders get wrong: Computing LTV on revenue instead of gross profit. Hosting, payment processing, customer support, and cost of goods sold all eat into revenue before any dollar is available to repay CAC. Skipping that adjustment doubles or triples the apparent LTV.

FAQ

How is lifetime value calculated?
The standard SaaS formula: average revenue per account times gross margin percent, divided by monthly customer churn rate. Use gross margin, not revenue, and cap the horizon at 3 to 5 years rather than assuming infinite life.

Why use gross margin instead of revenue in LTV?
Because only gross-margin dollars are available to repay CAC and fund operations. The portion of revenue that goes to cost of goods sold (hosting, payment processing, support) cannot be used to recover acquisition cost.

What is the difference between LTV and CLV?
None in practice. Lifetime value (LTV), customer lifetime value (CLV), and customer lifetime value (CLTV) all refer to the same metric. SaaS investors typically use LTV; consumer and e-commerce contexts often use CLV.

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