Lifetime value (or LTV) is one of the most important metrics to know when it comes to understanding the profitability of your business.
It tells you the value of of each customer over their entire lifetime, and therefore is vital to know to answer questions like how much you can afford to spend on acquiring customers.
How do you calculate lifeftime value?
To calculate LTV, we need to know how much a customer is worth to us per unit of time, and how many units of time we expect them to stay a customer for.
If our unit of time is months, then this equates to knowing the average customer's MRR, and the average number of months that they typically remain a customer for.
We can then write our equation for LTV as:
Where MRR refers to the monthly recurring revenue per customer, rather than overall MRR for your business.
The average number of months someone remains a customer for isn't typically measured directly. Instead, most SaaS businesses tend to focus on customer churn rate (see our guide to churn here).
If you know your monthly customer churn rate, you can rewrite the above equation as:
One question you might have in you mind is: what happens if my SaaS business has different subscription tiers, with different revenues?
If this is the case, you have two options:
- You could create an aggregate LTV metric, where your MRR is a blended average recurring revenue per customer across all subscription tiers, and your monthly churn is again a blended average churn rate across all tiers.
- You could create seperate LTVs per tier, where you replace 'MRR' by the tier price in each tier. Your monthly churn rate in this case should just reflect churn from customers on that tier.
An example calculation
To let this sink in, let's run through a quick example.
Let's say that:
- You're running a SaaS business which sells monthly subscriptions, at $49 a month.
- Your monthly customer churn is 4%
We can plug these values into our equation from earlier to work out what our LTV is:
Our LTV is $1,225 which means that, excluding any costs of servicing users (infrastructure and tech costs for most SaaS businesses), we can afford to spend up to this much on acquiring a user.
Modelling lifetime value in Causal
Causal is an interactive modelling tool, which lets you build fully customisable financial models for your SaaS business.
The below is an example of what a lifetime value model might look like in Causal. You can adjust the inputs at the top of the model to see how they affect the charts.
If you want to get under the hood, and see exactly how the model works, you can also click Use this template in the top right of the model.