Customer Life Time Value - Introduction

Customer Lifetime Value (CLTV or LTV) can also be defined as the dollar value of a customer relationship, based on the present value of the projected future cash flows from the customer relationship. CLTV is an important concept in that it encourages firms to shift their focus from quarterly profits to long-term health of their customer relationships. CLTV is an important number because it represents an upper limit on spending to acquire new customers. The purpose of CLTV metric is to assess the financial value of each customer. This is highly useful for analyzing subscription based (SaaS) companies.

Calculation

1. Average Revenue Per User (ARPU)

x

2. Gross Margin

x

3. User Life Time

–

4. Customer Acquisition Cost (CAC)

=

5. Customer Life Time Value (CLTV)

Average Revenue Per User (ARPU)

Total revenue during the preceding 12 month period divided by the average of the number of total customers at the beginning and end of the period (BoP / EoP)

a. Total Revenue / Average Customers during the period

b. Average Customers during the period = (Customers BoP + Customers EoP) / 2

Gross Margin or Contribution Margin

Estimated as the gross margin of the total revenue or subscription revenue

a. Revenue – COGS (Cost of Goods Sold)

b. Alternatively, Subscription Revenue – Subscription COGS (Cost of Goods Sold)

User Life Time

a. Average Life Time of Customer or Subscriber; or Average Contract Term (directly given in company filings)

b. Actual Cohort based calculation
1. The company sometimes gives cohort information. Eg: 20X1 customers stays with the company in the following manner

• Stays till 20X1: 40%

• 20X2: 20%

• 20X3: 10%

• Rest stays for 20X4 and beyond

2. We can analyze in following manner:

• 40% stays till 20X1 (means for 1 year) - Assuming 20X1 customers were since beginning

• 20% stays till 20X2 - for 2 years

• 10% stays till 20X3 - for 3 years

• Remaining (30%) stays till 20X4 and beyond - assume for 4 years

3. Life Time Calculation

• 40% x 1 year + 20% x 2 years + 10% x 3 years + 30% x 4 years

• Life Time = 2.3 years

c. Retention rate / Churn rate based calculation (preferable method)
1. Life Time (in years) = 1 / Annual Churn Rate
2. Annual Churn Rate = 1 – Annual Retention Rate (and vice-versa)
3. Annual Churn Rate = Monthly Churn Rate x 12 (and vice-versa)
4. Retention Rate sometimes given as renewal rate and churn rate sometimes given as attrition / cancel / turnover rate
5. Reverse Calculation can be done from Life Time to arrive at Churn / Retention Rates

Note 1: Monthly Retention and Rate is also APPROXIMATELY equal to: Annual Retention Rate ^ 12. Conversely, Annual Retention Rate is also APPROXIMATELY equal to: Monthly Retention Rate ^ (1/12)
Note 2: Monthly Retention Rate is NOT equal to: Annual Retention Rate / 12. Conversely, Annual Retention Rate is also NOT equal to: Monthly Retention Rate x 12
Note 3: We should preferably use retention rates. But sometimes, renewal rate and retention rate are used interchangeably. This serves the same purpose but there is slight difference in the manner of their calculations, which can cause slight variations in results.

• Annual Retention Rate is the percentage of customers on the last day of the prior year who remain customers on the last day of the current year

• Renewal Rate is the percentage of customers who renew annual or multi-year subscriptions that expire during the period

Life Time Revenue

• Average Revenue Per User (ARPU) x User Life Time

Customer Acquisition Cost (CAC) / Cost of Acquisition

a. Sales and Marketing Expense for consumer segment during the relevant period divided by Gross New Members for the period

• (S&M exp.) / Gross Adds

b. Alternatively, Sales and Marketing Expense divided by sum of Net Increase in Subscribers and Churn from old Subscribers - (This method is grossing up the net subscribers addition)

• (S&M exp.) / [Net Adds + Churn x (Subs BoP)]

Customer Life Time Contribution

• Life Time Revenue x Contribution Margin

Customer Life Time Value

• Life Time Contribution – Cost of Acquisition

This introduction deals with the basic meaning and the calculation of Customer Life Time Value. For further analysis of the Customer Life Time Value, refer to the link below:
Analyzing Customer Life Time Value