Analyzing Customer Life Time Value

Customer Life Time Value allows benchmarking of companies and helps to analyze the efficiency of companies in generating returns through their sales and marketing spend.

Net Present Value (NPV) of Life Time Value / Cost of Acquisition

• NPV of Life Time Value = [PV (Discount Rate, Absolute Life Time years, – Annual ARPU Contribution) + PV (Discount Rate, Life Time years, 0, – Annual ARPU Contribution x (Fractional Life Time years))] – Cost of Acquisition

Represents the multiple of net return in present value terms which the company generates per unit of sales and marketing spend to acquire customers

a. Annual ARPU contribution = ARPU x Contribution Margin

b. Absolute Life Time Years = Life Time in Years excluding the decimal part = INT (Life Time Years)

c. Fractional Life Time Years = Fractional part of Life Time Years

d. Example:

• Life Time Years = 3.63 years

• Absolute Life Time Years = 3 [It is not rounding off but simple exclusion of fractional / decimal part]

• Fractional Life Time Year = 0.63 [It is simply exclusion of fractional / decimal part]

e. Discount Rate should ideally be WACC; but brokers assume a flat one rate across companies companies to benchmark

Return on Investment (ROI)

• (Life Time Contribution / Cost of Acquisition)^(1/Subscribe Life in Years) – 1

Represents the percentage annual return a company generates through its sales and marketing spend to acquire customers

Alternate Long Method: Alternatively, we can use XIRR formula in excel to calculate the Internal Rate of Return, by arranging dates / cash flow in tabular format in excel
a. XIRR (Cash Flow Range, Date Range, 0)
1. Cash flow from zero period would be Cost of Acquisition
2. Cash flow from remaining period would be ARPU Contribution for each of the "Absolute Life Time Years"

• While, the last year would be showing proportional ARPU Contribution for that year based on Fractional Life Time year

3. Number of years / date range would depend on Life Time years

• Absolute Life Time years will be at an interval of a year each starting from a particular date which would be zero year till "Absolute Life Time Years"

• While, the last year would be Fractional Year based on proportional days for that year based on Fractional Life Time year

Life Time Contribution / Cost of Acquisition

• Total Life Time Contribution / Cost of Acquisition

Represents the multiple of absolute return (without the impact of discounting and without subtracting Cost of Acquisition) which the company generates per unit of sales and marketing spend to acquire customers

Life Time Value as a Valuation Methodology

Life Time Value is used mostly for benchmarking companies to check the efficiency of sales and marketing spend. But some Wall Street brokers also use the methodology to value the company.

The brokers use NPV of Life Time Value and subscribers to value the company for arriving at the Enterprise Value.

Calculation

1. NPV of Life Time Value

x

2. Subscribers or Customers

=

3. Enterprise Value

Note: Number of subscribers is chosen by brokers for a forward year based on its assumptions just like a forward year for trading comps multiple.

Once arriving at Enterprise Value, we can easily arrive at a fair value per share by adjusting for net debt and dividing the resultant with number of shares.

(The above write up includes various excel formulas, so needs to be read in that context)

This write up deals with the analyzing the Customer Life Time Value in various respects. For introduction and the calculation of Customer Life Time Value, refer to the link below:

Customer Life Time Value - Introduction