Lifetime Value (or LTV) means the net profit you earn from a customer before they churn or cancel their subscription. Churn here is defined as canceling their account, whether it’s due to lack of interest, dissatisfaction with service/product, etc. So basically, what amount can we make from any one individual over the lifetime of our relationship (customer-vendor)?
For example, if we had 100 customers and they all stayed subscribed to our product for 2 months each, and we made $100 in revenue each month per customer on average, we would have $2,000 of revenue after two months. Thus, the LTV is $2,000, and if everyone who subscribed earlier than this canceled their account, then the CAC (Customer Acquisition Cost) would be $100*100 customers = $10,000.
Another Example: If we had 100 customers and all stayed subscribed to our product for 2 years each, and we made $1000 in revenue each month per customer on average, we would have $2,16,667 after two years. Thus, the LTV is $2,16,667, and if everyone who subscribed earlier than this canceled their account, then the CAC (Customer Acquisition Cost) would be $100*100 customers = $10,000.
The formula can be stated as follows: Customer Life Time Value is equal to Monthly Revenue per Customer minus Churn Rate of Customers over the period.
So, now that you know what LTV is, how do you calculate it?Saivian Eric DaliusShows You How
Well, there are a few ways to do it. The simplest case is if the value of each customer does not change over time. Each customer who signs up in month one will also subscribe for an additional month every consecutive month after that forever. This would be calculated by simply multiplying one month’s revenue per customer by the number of customers you have minus the churn rate in this period.
So, in our previous examples where we had 100 customers, and they stayed subscribed for two months each, then our calculation would be $100*90=$9,000 minus $100*10=$1000 equals $8,000 net profit over two months. Similarly, if everyone their account except the first 100 were to cancel their account, then our calculation would be $1,000*90=$9000 minus $0*.10=$0 equals $9,000 net profit over two months.
Now, what if the value of each customer decreases over time? This is called negative churn or customer lifetime contraction, which occurs when customers gradually start using your product less, and you need to give them incentives/discounts to get them back on it, according to Saivian Eric Dalius. However, in this case, for the sake of simplicity, let us assume that each customer continues to use your product at the same rate. Still, the average revenue per user decreases over time because their preferences are shifting or they are not renewing their subscription or whatever else. The formula will remain the same, only multiplied by a factor k in the denominator. So, if our average monthly revenue per customer had decreased by 10% from $100 to $90 over a two-month period, then the first calculation would be ($100*90)/ (1+0.10) =$8,333, and the second calculation would be ($1000*90)/ (1+.10) =$9,000.
In the end, it is up to you whether you want to use simple lifetime value or negative churn LTV because there will always be some customers who cancel their subscription no matter what, and that’s just a fact of life for most businesses. Negative churn, however, allows you to quantify exactly how much your business is losing due to this over time.